December has been a bruising month for bond traders, and we've only just begun.
The value of the U.S. fixed-income market slid by $162.5 billion on Thursday while the euro area's shrank by the equivalent of $107.5 billion as a smaller-than-expected stimulus boost by the European Central Bank and hawkish comments from Janet Yellen pushed up yields around the world. A global index of bonds compiled Bank of America Merrill Lynch slumped the most since June 2013.
The ECB led by President Mario Draghi increased its bond-buying program by at least 360 billion euros and cut the deposit rate by 10 basis points at a policy meeting Thursday but the package fell short of the amount many economists had predicted. Fed Chair Yellen told Congress U.S. household spending had been “particularly solid in 2015,” and car sales were strong, backing the case for the central bank to raise interest rates this month for the first time in almost a decade.
"A lot of people lost money,” said Charles Comiskey, head of Treasury trading in New York at Bank of Nova Scotia, one of the 22 primary dealers obligated to bid at U.S. debt sales. “People were caught in those trades. In the old days, this would have been a one-week trade. In the new world, and in the less liquid market we live in today, it takes one day for the repricing.”
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The benchmark U.S. 10-year note yield jumped 13 basis points on Thursday, the most since Feb. 6. It fell two basis points on Friday to 2.30% as of 10:51 a.m. in London, according to Bloomberg Bond Trader data. The price of the 2.25% note due in November 2025 rose 6/32, or $1.88 per $1,000 face amount, to 99 19/32.
Germany's 10-year bund yield surged 20 basis points on Thursday to 0.67%. The two-year yield climbed 13 basis points to minus 0.31% after dropping to minus 0.454% before the ECB decision, the lowest level since Bloomberg began compiling data in 1990.
The bond rout on Thursday added weight to warnings from Franklin Templeton's Michael Hasenstab that there is a “a lot of pain” to come as rising U.S. interest rates disrupts complacency in the debt market.
(Related: Why bond markets aren't ready for higher U.S. interest rates)
“A lot of investors have gotten very complacent and comfortable with the idea that there's global deflation and you can go long rates forever,” Mr. Hasenstab, whose Templeton Global Bond Fund sits atop Morningstar Inc.'s 10-year performance ranking, said this week. “When that reverses, there will be a lot of pain in many of the bond markets.”
STOCKS DECLINE
Bonds sold off on Thursday even as U.S. stocks declined, with the Standard & Poor's 500 Index posting its biggest loss since Sept. 28, and as government and industry reports showed data falling short of economists forecasts. Asian stocks dropped on Friday.
The Bank of America Merrill Lynch MOVE Index, which measures price swings in U.S. debt, climbed for a fourth day Thursday, the longest stretch of advances since June.
Yellen, testifying before Congress's Joint Economic Committee, warned legislators about the dangers of the Fed waiting too long to raise rates. Economists surveyed by Bloomberg forecast a Labor Department report Friday will show U.S. employers added 200,000 jobs in November, above the monthly average of 67,000 for the past decade.
There's a 74% chance the Fed will raise its benchmark by its Dec. 15-16 meeting, according to futures data compiled by Bloomberg. The calculation assumes the effective fed funds rate averages 0.375% after the first increase, compared with the current range of zero to 0.25%.
“The type of divergence they thought was going to happen between the Fed and ECB was far too great,” Roger Bridges, chief global strategist for interest rates and currencies at Nikko Asset Management Australia in Sydney, said of market expectations. “What we're seeing is that maybe the Fed won't tighten as much as the market feared, and the ECB won't be as accommodative as the market hoped in its wildest dreams.”
