By Anna Hirtenstein, Joe Wallace and Paul J. Davies
Turmoil in financial markets triggered by an oil price war and the outbreak of the coronavirus sent government bond yields to historic lows Monday, as investors sought safety in the least risky assets they could find.
The yield on the benchmark 10-year Treasury plunged to a record low of 0.339% from 0.709% Friday, according to Tradweb. If it holds, the move will be one of the biggest single day shifts in decades.
The 30-year bond yield hit a low of 0.712%, down from 1.216%, implying investors are scared enough about the long-term future to accept a minuscule amount of interest for three decades.
"I've never seen this and I've been doing this for 30 years,"said Scott Thiel, chief fixed income strategist at BlackRock. He said investors were fleeing to bonds perceived as safe to protect their portfolios as stocks, commodities and the value of riskier corporate debt dropped sharply.
"You have go to let the dust settle before you look at the [valuation] levels. It's about risk management," he said.
Yields on government bonds in Europe, already in negative territory for some economies, plunged even lower. Germany's 10-year bund traded at minus 0.883%, and the U.K. equivalent hit 0.084%. The U.K.'s 2-year bond yield briefly dipped below 0 this morning before recovering to 0.003%.
Yields, which fall as bond prices rise, are tumbling faster among longer-dated bonds than shorter-dated Treasurys, which is a signal that markets expect a significant economic slowdown that will last for some time. If longer-dated yields fall below shorter-dated ones, known as a yield curve inversion, that typically signals recession ahead.
"It's happening already, it's massive in terms of flattening," said Jorge Garayo, head of inflation strategy at Société Générale, referring to the Treasury yield curve. "They're still not inverted, but going toward inversion. It's a very worrying factor when the curve inverts."
U.S. interest rates remain in positive territory. Investors are skeptical that will change without the Federal Reserve altering its current stance, which is not to use negative rates as a policy tool.
"We do not [fore]see negative policy rates in the U.S.," said John Briggs, head of strategy for the Americas at NatWest Markets. Markets are currently pricing in a restart to the Fed's quantitative easing, or bond-buying program, for which new purchases ended in 2014.
He doesn't think 10-year yields will remain very long at such low levels.
"I don't see that as sustainable, but for a while here it is not about value, it is about need," he said.
The upheaval in markets spread to corporate bonds, which suffered another heavy selloff Monday. Hardest hit was riskier high-yield credit, where there is more exposure to the energy sector in the U.S. and to other industries already under significant pressure such as retailers in the U.S. and Europe.
In junk bonds, the selloff in the U.S. and Europe is already worse than it was in late 2015 and early 2016 when a collapse in energy prices put pressure on highly indebted U.S. energy groups that need high oil prices to be profitable. The fallout might be worse this time because more investors appear to be fleeing passive bond funds and exchange-traded funds.
"Five years ago the high-yield market 'only' had falling commodity prices to deal with. This time round liquidity is already a huge concern following the impact of the coronavirus selling," Deutsche Bank strategist Craig Nicol said Monday. "Outflows, particularly from passive funds, have already hit record levels."
Investors said much of the activity Monday was happening in the credit derivatives market, where investors can buy protection against companies defaulting on their debt. This market is faster to trade and more liquid than the bond market and allows banks and other funds to quickly adjust their exposure to whole sections of the market.
A good guide to the panic sweeping credit Monday is the iTraxx Crossover index of derivatives tied to junk-rated European bonds. The cost of protecting those companies against default saw one of its sharpest ever jumps when it rose to EUR532,000 (around $600,000) annually to cover EUR10 million's worth of bonds for five years. That was up from EUR378,000 at Friday's close.
The U.S. high yield market might be more vulnerable than Europe's because it has a large number of energy companies, many of whom were vulnerable before Monday's oil price plunge.
"We are likely to see more threats of or realized restructurings in that space [energy]," said Fraser Lundie, head of credit at Federated Hermes in London. "That was already a real possibility for some companies, but this [oil price fall] could accelerate that."
The slide in oil prices could pose difficulties for bond issuers outside the energy sector. If defaults among U.S. oil and gas producers rise beyond a certain level, companies in other sectors and countries will start to struggle to access credit, said Viktor Hjort, head of credit strategy at BNP Paribas. "That ultimately is the negative aspect to lower oil," he said. "There is a real risk and that is tighter credit conditions."
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