October was a bad month for bond markets. German Bunds have risen 30bps, making it their worst month since 2013, whilst U.S. Treasuries have climbed to their highest levels since May 2016. According to Pioneer Investments, the main reasons for the sell-off are:
- Increased probability of a Fed rate hike in December (now 73%) – the recent economic data in the U.S. (and globally) has been just about strong enough to allow the Fed to hike in December and not, in our opinion, upset markets.
- All about inflation breakevens – real rates haven’t moved. In the major markets, the majority of the recent sell-off can be attributed to a rise in inflation expectations, due to the increase in the oil price over the last 12 months.
- Stronger UK data sees market pricing next rate move as a hike – as mentioned below, Q3 GDP data in the UK was sufficiently strong to make the market consider that further rate cuts may not be needed.
- Euro OverNight Index Average (EONIA) no longer pricing in rate cuts – as in the UK, recent strong economic data in Europe (better IFO survey data and German Industrial Production numbers), along with increasing inflation makes it unlikely that the ECB would cut the deposit rate further.
- Stretched positioning – data from the Eurex futures exchange and anecdotal evidence from counter-parts suggest that many investors were long duration. The cutting of these positions as bond yields rose exacerbated the selling pressure.
- Bond volatility had been close to historic lows – the Merrill Lynch Option Volatility “MOVE” index showed bond market volatility had moved back towards the very lows levels seen in May 2013 and August 2014. In both cases, volatility rebounded sharply higher shortly afterwards.
Pioneer's David Greene says: "Whilst we have some sympathy with the move higher in yields, and are running a short duration position ourselves in Europe, we don’t subscribe to the belief that this is the start of another “taper tantrum”."