The bond bubble keeps inflating

Most major stockmarkets remain down on the year, but government bonds continue to gain ground.

In times of crisis, investors traditionally look to bonds to cushion the pain. Most major stockmarkets remain down on the year, while government bonds have gained ground. The yield on the US ten-year Treasury has fallen from 1.8% at the start of January to about 0.7%. Germany’s ten-year Bund yield has fallen further into negative territory, down from -0.22% to almost -0.5%. 

Bond yields move inversely to prices, so falling yields imply capital gains for bondholders. The yield on the US two-year Treasury fell to a record low of 0.105% at the end of last week. 

The bond market is being driven by two key forces: higher government spending and central banks’ quantitative easing (QE), says Emily Barrett on Bloomberg. On the one hand, governments are issuing vast new tranches of bonds in order to pay for pandemic rescue measures. The US government is preparing to issue a record $96bn in new bonds over the coming weeks to finance an annual deficit ballooning towards $4trn. 

Bond investors would usually demand higher yields to fund all that new spending, but this effect is being counteracted by vast QE, with central banks soaking up much of the new bond supply with printed money. The Federal Reserve has bought $1.5trn in US bonds over the past two months, while the Bank of England has expanded its QE programme by £200bn. 

One reason that investors are willing to pay up for bonds with such low yields is that they do not have many other low-risk places to put their cash. Interest rates sit at just 0.1% in the UK and are negative in the eurozone. 

Futures markets show that traders think there is a chance American rates could also turn negative by the end of the year, says Justin Lahart for The Wall Street Journal. In such a severe crisis you should “never say never”. 

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