domingo, 17 de junio de 2018

domingo, junio 17, 2018

The Next Bond Rout: It’s Bigger Than Italy

By Evie Liu

      Photo: ALBERTO PIZZOLI/AFP/Getty Images 


Now, that was a bond rout.

One week ago, concerns that Italy would leave the euro zone caused yields on its two-year notes to surge as high as 2.7%, as investors fled its bond markets for safer assets. The yield had been negative just two weeks earlier. (Bond prices and yields move in the opposite direction.) 
And no wonder. The chances of Italy ditching the euro zone increased—putting the stability of its bond market in jeopardy—after President Sergio Mattarella vetoed the two anti-establishment parties’ choice for finance minister. But investors had been shying away from Italy’s bonds even before last week’s crisis—and though things have stabilized since then, many questions remain.



It would be easy to assume the panic that gripped Italy’s bond market was specific to the country’s political precariousness. But maybe not. Technical evidence suggests that a reckoning may be coming for all risky bonds, according to the Andrew Addison of research firm the Institutional View. If he’s right, Italy may just be the beginning.

The spike in Italy’s bond yield didn’t come out of nowhere, though it certainly seemed that way for the two-year note. The yield on Italy’s 10-year bonds had been rising steadily since finding support around 1% twice between 2015 and 2017—creating what is known as a “double bottom,” in technical parlance—and establishing a range between 1.04% on the downside and 2.39% on the upside.

That range finally broke on May 21, just six days before Mattarella’s veto.

A breakout like this suggests there could be more room for yields to rise. Addison projects Italy’s 10-year yields should reach 4% (a consistent support level tested many times over the past 20 years) and may even reach 4.5% (nearly doubling the old resistance level of 2.4%) by the end of the year.




Investors might be expected to demand higher yields from Italy’s bonds due to the perception that they’re more dangerous than they were two weeks ago. But there is evidence that the investors are beginning to prefer safer bonds across Europe as well.

The spread between high-quality European bonds—as represented by the Iboxx Euro Non-Financials AA Total Return Index—and lower-quality ones—as represented by the Iboxx Euro Non-Financials BBB Total Return Index—has been dropping for over two years. Since April, the gap between the values of the two benchmarks has been narrowing, and now sits at -10.52 points as of last Friday, up from -11.85 points in April.

It’s a sign that investors now view higher-quality bonds more favorably, which could mean the beginning of a “risk-off” period, Addison says.



And not just in Europe. Investors have begun shying away from global high-yield bonds as well. During the past four months, the Bloomberg Barclays Global High Yield Total Return Index, which includes 34,000 high-yield bonds in the U.S., Europe, and emerging markets, has dropped 3.5% to 1281.8 as of last Friday, its lowest level since last August.

The damage looks even worse in chart form. The Bloomberg High Yield Index had been in an uptrend for about two years, but the recent decline formed a “rounding top”—represented by an upside-down “U” shape in the chart—breaking that trend and suggesting more downside to come.



When the market’s riskiest bonds start to dip, it can be an early sign of a weakening economy, even a possible recession, Addison says.

We’re not saying we’re there yet, but it’s something to keep an eye on.

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