Historic global bond market crash threatens liquidation of world’s most crowded trades, BofA says

Historic global bond market crash threatens liquidation of world’s most crowded trades, BofA says

Global government bond markets are mired in what BofA Securities strategists say is one of their biggest bear markets on record – which, in turn, threatens the ease with which investors can exit trades the world’s most crowded, if necessary.

Those trades include long positions in the dollar, US technology companies and private equity, said strategists Michael Hartnett, Elyas Galou, and Myung-Jee Jung. Bonds are generally regarded as one of the most liquid asset classes available to investors; when liquidity dries up there, that’s bad news for all other types of investment, other analysts said.

Financial markets are yet to price in the worst results for inflation, interest rates, and the economy around the world, despite a decline in global equities and bond selling in the US and UK on Friday. Dow DJIA industrials,
-2.05%
they were off more than 700 points at their lows, flirting with falling into bear market territory, and the S&P 500 SPX,
-2.21%
threat to take out to close June low.

US yields were trading at multi-year highs. Meanwhile, UK, German and French government bond rates have risen at the fastest clip since the 1990s, according to BofA Securities.

“Inflation/rates/recession shocks haven’t ended,” plus the bond crash in recent weeks “means that there are rises in credit areas, stocks are not yet in,” BofA strategists wrote in a note issued Thursday. They said investor sentiment is “undoubtedly” the worst since the global financial crisis of 2007-2009. The strategists also see the fed funds rate target, Treasury yields, and the US unemployment rate all heading to between 4% and 5% in the coming months and quarters.

Government bonds have lost 20% this year, as of Thursday – the worst losses since 1920, according to BofA. Throughout 2022, global government bonds are on track for one of their worst performances since the Treaty of Versailles, signed in 1919 and entered into force in 1920 — establishing the terms of peace at the end of the First World War. bond prices move in opposite directions, so rising yields reflect the deleveraging prices of government debt.

Source: BofA Global Investment Strategy, Bloomberg

Liquidity is important because it ensures that assets can be bought or sold without significantly affecting the price of that security. Without liquidity, it is more difficult to convert an asset into cash without losing money against the market price.

Government bonds are the most liquid asset in the world so “if the bond market doesn’t work, no other market does, really,” said Ben Emons, managing director of global macro strategy at Medley Global Advisors in New York.

“Elevated yields of credit continue to dry up and will hit the global economy hard,” Emons said by phone Friday. “There is a risk of a ‘sold everything’ like March 2020, with people pulling out of markets amid more volatility and finding they can’t really trade.”

A historic bond sell-off in the UK on Friday, fueled by eroding investor confidence over the government’s miniscule budget plan, only exacerbated concerns about deteriorating liquidity, particularly in the otherwise safe Treasury market normal.

Read: The next financial crisis may already be here – but not in the way investors might expect

In the United States, Federal Reserve officials have shown they are willing to break something with higher rates — whether in the financial markets or the economy — to reduce the hottest period of inflation in the last 40 years.

Part of this month’s decline in global bond prices is “the very real fear that the central bank will spiral upwards in a competitive race to maintain currency viability and not be the last country with the inflation bag to escape,” he said. Jim Vogel, deputy executive officer. president at FHN Financial in Memphis.

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