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Categorized | Capital Markets, Economy

Long-dated bonds star amid market upturn

Posted on March 31, 2016

Governor of the Bank of Japan (BoJ) Haruhiko Kuroda explains his negative interest rate plan using a board during his regular press conference in Tokyo©Getty

Governor of the Bank of Japan Haruhiko Kuroda explains his interest rate policy

Stock markets have staged an impressive comeback this quarter, clawing back their severe losses from January and February but the real stars of financial markets this year have been long-dated government debt.

While the March rebound has helped the FTSE All World index recover almost all of its early-year losses, longer maturity government bonds have been on a tear since the start of the year, propelled by subdued inflation, negative interest rates and low yields on shorter-dated debt.

    Eurozone government bonds with a maturity of 10 years or above have returned 8 per cent in the first three months of the year, according to Bloomberg data, a performance only beaten in two quarters since 1998.

    German “long bonds” have returned over 10 per cent and longer maturity UK gilts have gained over 7 per cent.

    Longer dated US Treasuries have handed investors a 7.3 per cent gain but both eurozone and US “govvies” have been put to shame by the performance of long maturity Japanese government bonds, which have returned 10.6 per cent in the first quarter of 2016. That is the best quarterly performance since at least 1991.

    The blow-out performance is a reflection of the paucity of returns available in shorter dated debt.

    Quantitative easing and negative rates in the eurozone and Japan have pushed the yield of trillions of dollars worth of bonds into negative territory, forcing many investors into longer-duration debt that yields more.

    “You can either go down in credit quality, and many people don’t want to do that, or just go nuts on duration,” said Jack Flaherty, a bond fund manager at GAM.

    As a result, long-term borrowing costs for a host of major countries have fallen precipitously. The US, Germany and Japan can now borrow for 30 years at just 2.64 per cent, 0.84 per cent and 0.53 per cent, respectively.

    “There’s been a significant change in yields in the first quarter, not just domestically but also in Europe and Japan,” said Alex Roever, head of US rate strategy at JPMorgan. “The increase and anticipation of quantitative easing has pushed yields even lower . . . There’s now just much less positive yielding debt out there.”

    However, the performance of longer dated government bonds is not just caused by technical factors such as the swelling universe of negative-yielding debt but also reflects still-muted expectations for global economic growth and inflation.

    Strategists still mostly expect bond yields to climb in the coming year — albeit gently.

    The 10-year US Treasury yield is on average forecast to rise to 2.3 per cent by the end of 2016, and the German, UK and Japanese equivalents to 0.6 per cent, 2 per cent and 0.01 per, respectively, according to Bloomberg data.

    Even if many fund managers doubt that yields will climb meaningfully — or at all — in the coming year, the performance of the first quarter will be difficult to replicate, given the limited scope for safer government bond yields to fall much further.