The bond market had been metastasizing into a bubble long before the coronapanic pounded global financial markets. But while the bubble has yet to pop, the ruptures in the fault line are already showing concerning signs that bonds might be on the verge of a crisis or that the next economic collapse will trigger a meltdown never seen before. Treasurys or corporate bonds – no investor is safe in this chaos.
Forging a Bond
During the market crash, the benchmark 10-year Treasury plummeted to an all-time low of 0.318% before rebounding to as high as 1%. Other 10-year bonds around the world, including those in the subzero range, picked up steam at the end of the trading week. Investors appeared to be satisfied by the government’s response to tackling the coronavirus and dived back into equities, which was evident by the dramatic 2,300-point climb during President Donald Trump’s Rose Garden press conference.
The Federal Reserve’s monumental intervention quashed panic, too. The U.S. central bank revealed details of its $1.5 trillion plan that involves about $80 billion in asset purchases: $60 billion to boost cash reserves and another $20 billion of reinvestments from maturing agency bonds. Plus, the New York Fed Bank is acquiring $37 billion in zero to 30-year maturities. Officials say the purpose of this bond-buying scheme is to stabilize the Treasury market after the spread between what buyers were willing to pay and what sellers were demanding had not been seen in more than 40 years.
It is not just Treasury notes that are suffering. State and local government bonds are also in deep trouble. Municipal bonds suffered a weekly loss of 4.2%, the biggest decline since May 1987. One index – the Bloomberg Barclays muni-bond index – saw its market capitalization crumble $66 billion. And many Wall Street firms say investors pulling out their money out of bonds and mutual funds will persist until COVID-19 is either resolved or contained.
Corporate bonds have not been immune either. The $9 trillion market is facing a tremendous volume of outflows caused by forced selling to cover losses and margin calls, which leads to a lack of liquidity. Even the investment-grade corporate bonds are facing tremendous liquidity problems. Nearly $16 billion of investment-grade bond funds were shed, while another $11.2 billion from high-yield bond funds were wiped out. It harkens back to the 2008 financial crisis when investors simultaneously dashed to the exit door. Moreover, the credit spread indicates that investors are less interested in purchasing corporate debt amid all the havoc. Should the plunge persist, the main concern in this area of the bond market is that investors will be left to sell their most illiquid debt to raise cash.
The fractures in the bond sector are not only relegated to the U.S. but all over the world. The European Central Bank (ECB) essentially conceded that there was not much that stimulus could do to limit the economic fallout from the virus and combat the pandemic. ECB head Christine Lagarde refrained from cutting interest rates, though she did reveal measures to support bank lending and expand its quantitative easing initiative.
As part of its reboot, China is beginning to open its bond market and selling billions of dollars’ worth of notes. So far, traders have been attracted to the products. But since Beijing – both the public and private sectors – had trouble covering its previous debts, the world’s second-largest economy could have a harder time paying off these bonds without considerable interventions in the form of bailouts.
The Name’s Bond
Was the global bond market regularly given a clean bill of health, or did it always show signs of illness?
The theme in a post-coronavirus world is that we will inevitably forget about the problems that existed before the global pandemic. It is a convenient scapegoat that will allow us to blame any abnormality or hiccup on COVID-19. We might think that the bond landscape was in pristine condition before the outbreak, but here is one of the many damning statistics that dominated bond-related headlines: About $15 trillion of government bonds worldwide trade at negative yields. The other newsworthy trend had been the myriad of countries issuing century bonds at a near-zero interest rate. There is another word to fret about: Default. This had been a concern before the crash, and the consternation might be amplified in a world of uncertainty.
Whether it is the government at any level defaulting or the private sector throwing their hands up in defeat, the future of the bond industry does not instill confidence among professional and retail traders. For yield-hungry investors, there is nowhere to hide, except in your panic room full of toilet paper.
Read more from Andrew Moran.