Bonds Show Strain as Best Rally Since ’97 Wilts: Credit Markets

Aug 01, 2014 6:27 am ET

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Aug. 1 (Bloomberg) -- Bond bears who retreated amid the biggest rally in the global fixed-income market since 1997 are starting to sense vindication.

From North America to Asia and Europe, bonds of all types were poised to deliver their smallest gains since March, according to the Bank of America Merrill Lynch Global Broad Market Index, which tracks $43 trillion of securities. Returns of 0.24 percent through July 30 added little to the 4.23 percent rally in the first half of the year.

Bond investors, who have accepted some of the lowest yields in history as major central banks suppressed benchmark interest rates, see little reason to push them even lower as turmoil in places such as Ukraine and Gaza weigh on global economic growth and the Federal Reserve moves closer to curbing its stimulus measures. Returns last month were led by the safest securities, a turnaround from the first half when riskier bonds led the way.

“The perspective that investors have is that they are going to lose out one way or the other,” Ashish Shah, the New York-based global head of credit strategies at AllianceBernstein LP, which oversees about $250 billion in fixed-income assets, said in a telephone interview. “It has been a good year in credit, a lot of investors have had good performance and they want to lock it in by reducing risk in their portfolio.”

Small Gains

Most assets classes underperformed in July, with MSCI ACWI Index of global equities falling 1.33 percent in its first drop since January and the Bloomberg Commodity Index, which tracks futures contracts on 22 physical commodities, posting a 5 percent decline.

Bond gains were restrained by losses in speculative-grade debt, with the Bank of America Merrill Lynch Global High Yield Index sliding 0.5 percent, trimming gains for the year to 5.34 percent. The last time the index fell was August 2013. High- yield, high-risk, or junk, debt is rated below Baa3 by Moody’s Investors Service and lower than BBB- by Standard & Poor’s.

Investment-grade corporate bonds returned 0.16 percent, the least of 2014 and bringing gains for the year to 5.51 percent.

Forecast Lowered

Growth is still weak, according to the International Monetary Fund which lowered its outlook for global expansion this year to 3.4 percent on July 24, compared with a 3.6 percent prediction in April.

While forecasters foresaw higher yields at the start of the year as the U.S. economy gained momentum, the increase didn’t materialize as a contraction in the economy in the first quarter buoyed investor expectations of Fed’s easy-money policies remaining in place for a longer period.

Yields on bonds globally reached an average of 1.75 percent on July 30, the Bank of America Merrill Lynch indexes show, up from 1.73 percent at the end of June. That compares with an average of about 3.1 percent over the past 10 years.

Geopolitical tensions led investors to seek the safest assets. The Bank of America Merrill Lynch index of sovereign bonds returned 0.41 percent, pushing gains for the year to 4.37 percent. U.S. Treasuries failed to keep up, losing 0.16 percent as the Fed moved closer to ending its bond-purchase program.

Ukraine, Gaza

Fighting between pro-Russian rebels and the Ukrainian government escalated last month after an airliner was brought down, killing 298 people on board.

Israel and Hamas in Gaza agreed today to a three-day humanitarian cease-fire, the longest break in more than three weeks of fighting, the U.S. and United Nations said.

Investors were reminded of the risks of investing in fixed income this week as Argentina defaulted on its debt.

“Any time a country defaults on its obligations, selective or otherwise, it’s an event that warrants closer attention and a heightened focus on risk,” Edward Marrinan, a credit strategist at RBS Securities, said in a telephone interview.

While regional conflicts simmered, U.S. gross domestic product rose at a 4 percent annualized rate last quarter, after contracting 2.1 percent in the first three months of the year, according to the Commerce Department. The second-quarter expansion exceeded the 3 percent median forecast of 80 economists surveyed by Bloomberg.

“It’s been a very strong year for fixed income, and to justify a higher price, we need to see weaker economic data,” Anthony Valeri, a market strategist in San Diego with LPL Financial Corp., said in a telephone interview. “The strength in the bond market was unsustainable.”