Banks, Financial

RBS emerges as biggest failure in tough UK bank stress tests

Royal Bank of Scotland has emerged as the biggest failure in the UK’s annual stress tests, forcing the state-controlled lender to present regulators with a new plan to bolster its capital position by at least £2bn. Barclays and Standard Chartered also failed to meet some of their minimum hurdles in the toughest stress scenario ever […]

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Economy

Draghi: Eurozone will decline without vital productivity growth

It’s productivity, stupid. European Central Bank president Mario Draghi has become the latest major policymaker to warn of the long-term economic damage posed by chronically low productivity growth, as he urged eurozone governments to take action to lift growth and stoke innovation. Speaking in Madrid on Wednesday, Mr Draghi noted that productivity rises in the […]

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Currencies, Equities

Scary movie sequel beckons for eurozone markets

Just as horror movies can spook fright nerds more than they expect, so political risk is sparking heightened levels of anxiety among seasoned investors. Investors caught out by Brexit and Donald Trump are making better preparations for political risk in Europe, plotting a route to the exit door if the unfolding story of French, German […]

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Banks

Barclays: life in the old dog yet

Barclays, a former basket case of British banking, is beginning to look inspiringly mediocre. The bank has failed Bank of England stress tests less resoundingly than Royal Bank of Scotland. Investors believe its assets are worth only 10 per cent less than their book value, judging from the share price. Although Barclays’s legal team have […]

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Banks, Financial

Banking app targets millennials who want help budgeting

Graduate debt, rent and high living costs have made it hard for millennials to save for a house, a pension or even a holiday. For Ollie Purdue, a 23-year-old law graduate, this was reason enough to launch Loot, a banking app targeted at tech-dependent 20-somethings who want help to manage their money and avoid falling […]

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Categorized | Capital Markets, Financial

Bond investors wake up to QE withdrawal


Posted on May 31, 2013

Jeremy Renner stars in The Hurt Locker©Summit

Explosive scenario: central banks are still expected to act as bomb disposal squad when needed, but fears are growing

What is the difference between 1.6 per cent and 2.2 per cent? Either: not much, or a potentially explosive shift in the way global investors view the world that presages turbulent market conditions ahead.

Yields on US government debt, which move inversely to prices, have surged during May and peaked this week, leaving holders nursing their worst monthly loss since December 2010. Ten-year Treasury yields hit 2.23 per cent on Wednesday, up from 1.61 per cent at the start of May, and were back to 2.20 per cent in volatile Friday trading.

    The immediate cause was concern that the Federal Reserve would soon start to “taper” its open-ended bond purchases – with far-reaching consequences for US debt markets and perhaps signalling a turning point in the 30-year Treasury bull market.

    As investors awoke to the realisation that extraordinary monetary stimulus through “quantitative easing” cannot last for ever, repercussions were felt worldwide. Emerging economies’ bond markets also saw yields jump sharply, as did Japan, where the equity market went into a tizzy. At one point the Nikkei 225 index was down 15 per cent from last week’s peak.

    Unsettling investors were worries that the central bank “put” led by the US Fed that has driven asset prices sharply higher over the past year – beyond levels justified by economic fundamentals – was unwinding. “I can’t say where, but there will be unexploded bombs going off as yields start to rise,” says Kevin Gaynor, global head of asset allocation at Nomura.

    Confidence remains high that central bankers will continue to support economies – and act as the bomb disposal squad when needed. Even the US has yet to see a self-sustaining recovery while “the Bank of Japan has its work cut out”, argues Mike Amey, head of sterling portfolios at Pimco. “We think that the bull market is over, but we don’t believe the secular bear market has started.”

    The stresses in markets, however, highlighted their vulnerability to any hint of a shift in Fed support. Central bank action over the past four years has compelled investors to borrow at low overnight rates and pile into higher yielding debt in so-called “carry trades”. Nobody knows the extent of such positioning, but the danger is that investors try to get ahead of any attempt by the Fed to remove the punchbowl.

    “There is a risk that, even before the growth issue is clear, the markets move to an extreme as so much leverage and one-sided positions have built up at the Fed’s request over recent years,” says Richard Gilhooly, strategist at TD Securities.

    This week’s turmoil “underscores concern about emerging market excesses, which have been the side-effect of very low and stable US Treasury yields”, adds Mr Gaynor. “If they are going up, we should be more worried about things like leveraged financial systems in emerging economies.”

    Ripple effects are already clear in US investment grade corporate debt markets, where total returns for the year have fallen back into negative territory. Blue-chip companies have sold debt at record low interest rates, and there is “no way investment grade bonds can escape a violent sell-off in Treasuries”, warns Edward Marrinan, head of US macro credit strategy at RBS Securities.

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    However, the impact – so far at least – has been noticeably less pronounced on US equities and junk-rated debt. “If we see stability in Treasury yields, then high-yield bonds can skate through,” says Mr Marrinan. “By virtue of their higher coupons and capital gains, the asset class has greater insulation than investment grade bonds against a back-up in Treasury yields.”

    A better performance by equities and high-yield bonds is consistent with the view that Fed tightening would only come when US economic prospects picked up, reducing the default risk of lower-rated companies and increasing earnings prospects. In Europe, the pattern in bond markets has been the opposite, however, with a bigger sell-off recently in high-yield than investment grade markets.

    The next big event is the May US jobs data due at the end of next week. “A strong payrolls number would add to investors’ belief that the Fed could pull back on their bond buying,” says Ajay Rajadhyaksha, strategist at Barclays.

    Jay Mueller, senior portfolio manager at Wells Capital, adds: “The Fed is in no hurry to change things, but if we get stronger economic numbers, then investors will connect the dots and say we have moved to a higher gear.”

    A US economy in higher gear would intensify the upward pressure on bond yields. Mr Rajadhyaksha argues the Fed would want to avoid an unruly sell-off that could imperil the economy’s progress. So credit markets and equities would remain supported.

    But still there could be plenty of unexpected eruptions. Didier Saint-Georges, investment committee member at Carmignac, the French fund manager, warns: “As the destiny of financial markets hinges more than ever on central bank action, increased volatility is going to be part of our life for the medium-term future.”