Last Updated on Monday, 4 September, 2023 at 4:51 pm by Andre Camilleri
Sovereign bond markets have been going through a period of volatility and unpredictability. This is demonstrated by examining the yield fluctuations of the 10-year German bund, the benchmark for the Eurozone and the 10-year US Treasury yield (Figure 1).
Daily changes in the DE and US sovereign bonds yields, as per Figure 2, show that these swung in different directions, with significant magnitudes at times. In fact, the standard deviation for the period depicted (US: 7.44, DE: 7.65), is higher than that calculated for the past 10-years (US: 4.39, DE: 5.08). The highest daily yield increase for the reviewed period, was of 21bps for the US 10-year yield and 18 bps for the DE 10-year yield, whilst the largest downward move touched 32bps and 34bps, respectively.
Various factors and events caused and continue to create market volatility. Inflation readings and market expectations on how the Federal Reserve Bank (FED) and the European Central Bank (ECB) will react to such figures, were the main cause for volatile sovereign bond markets. As depicted in Figure 3,inflation rates in both the Eurozone and the United States, peaked in 2022. Two main factors contributed to soaring prices. Firstly, Covid-19 resulted in supply bottle necks, leading to upward price pressures. Additionally, fiscal stimulus to combat the adverse economic impact of the pandemic, has boosted demand, also at a time of supply constraints created by the pandemic. Secondly, the invasion of Ukraine by Russia impacted supply of food and energy. In fact, according to Eurostat calculations, increases in food and energy prices, accounted for more than two-thirds of the HICP inflation rate for 2022.
To tame high inflation rates, both the ECB and the FED followed an aggressive monetary policy tightening path between 2022 and 2023, shown in Table 1. Whilst the FED started to hike rates in March 2022, the ECB followed later during the year, specifically in July 2022. Yields fluctuated throughout this period as investors tried to gauge the next move of the main central banks. In total, the ECB raised its policy rates by 425bps since the start of its monetary policy tightening cycle, while the Fed hiked its policy rates by a total of 525bps. In terms of yields, the 10-year US yield added around 100 bps whereas the German 10-year yield increased by approximately 121bps, throughout the hiking period. Although inflation rates, in both the EA and US have declined somewhat, with the latest rates standing at 5.30% for the EA and 3.20% for the US, these are still somewhat higher than the inflation target of 2%.
Apart from inflation data, bond markets were also impacted by other economic indicators. These include employment data, such as the unemployment rate and the nonfarm payrolls report in the US. Another relevant indicator is the Producer Price Index (PPI), which monitors costs related to manufacturing goods, that may be reflected in consumer prices. Oil prices, consumer activity, retail spending, the housing market and investor activity, are all thoroughly analysed by bond investors. At times, these statistics provided mixed views on whether the economy would fall into a recession or come to a soft landing. This uncertainty created further instability across bond markets, with yields fluctuating depending on the interpretation given to such data. Latest Purchasing Manager’s Index (PMI) from Germany indicates that economic activity shrank in August at the sharpest rate in more than three years. Sharp declines in yields were observed after the release of such data.
Furthermore, in the first quarter of 2023, bond investors were impacted by turmoil in the banking system. The month of March witnessed the collapse of some small regional banks in the US and a Swiss bank. Silicon Valley Bank (SVB), a US based bank, experienced a bank run on 10 March, with US regulators intervening on 12 March to guarantee SVB depositors the full amount of their deposits. Signature Bank of New York was also shut down by US authorities to avoid further contagion. In Europe, Credit Suisse Bank collapsed on 17 March, with UBS acquiring the bank with an estimated value of $3.25bn. Yields dropped significantly throughout this period, as investors fled to the safety of sovereign bonds.
In May 2023, the debt ceiling tensions in the US have also contributed to stress in global bond markets. Inability by Congress to reach an agreement on the debt ceiling implied that the US Government would be unable to finance its debt, being already at an exceptional high level. Bond yields rose considerably, but stabilised as an agreement was reached towards the beginning of June.
The question remains where the bond market is heading in the coming months. The evidence suggests that the direction of yield movements heavily depends on economic data and the response of central banks in advanced economies. The ECB’s upcoming monetary policy meeting scheduled for September 14 and the Fed’s on September 19 and 20 will be important meetings that may shed some light on the future path of monetary policy, although given the elevated uncertainty, it is unlikely that these will be signalling any firm future commitments.
Authors: Emmanuel Farrugia and Maria Micallef from Central Bank of Malta