Bond Market Mayhem Lives On in These 10 Charts

(Bloomberg Opinion) -- The first week of March felt like a monumental one in the $100 trillion global bond market. Traders were staring at chaos in seemingly every corner of the world because of the coronavirus outbreak and began bracing themselves for some turbulence.

It turns out that was just the warm-up act for this past week.

Just about all the measures of bond-market mayhem that I flagged six days ago have only become worse as stocks plunged into a bear market and investors slammed the panic button across asset classes. Liquidity is everyone’s top priority, and it’s as scarce as ever, even in U.S. Treasuries, supposedly the world’s deepest and most liquid bond market. Credit spreads and the cost to insure against default have exploded on investment-grade and high-yield corporate debt alike. Ten-year U.S. municipal bond yields rose by 45 basis points in a single day, the most ever. Across the Atlantic, Italy’s 10-year yield jumped by as much as 72 basis points on the same day for entirely different reasons.

Last week I called the bond market sentiment “creeping doom-and-gloom.” That’s no longer the case: The doom and gloom has arrived. Here are 10 charts that show how investors have come to terms with the prospect that the pandemic will quite possibly tip the global economy into a recession and cause companies worldwide to face credit downgrades at best or outright defaults at worst.

The journey across bond markets has to begin again with 30-year Treasuries:

Bond traders in the U.S. woke up Monday to see the entire Treasury yield curve trading below 1% for the first time in history. The 30-year yield dropped to as low as 0.6987%, staging the biggest intraday decline on record. Investors openly suggested that it was only a matter of time before rates hit 0% or lower.

By Tuesday, however, the long-bond yield would reach as high as 1.3236%, or about 63 basis points above where it was just 36 hours earlier. Both on the way down and the way up, the swings were unprecedented since the 30-year maturity was introduced in the 1970s. Treasuries are not supposed to trade like that.

It soon became clear that the world’s biggest bond market was dealing with its worst liquidity conditions since 2008. Benchmark yields increased even when stocks plunged. Simply put, Treasuries weren’t acting like the safe haven they’ve always been. That forced the Federal Reserve into action, with the central bank announcing Thursday that it would start purchasing government securities of all maturities, rather than just short-term bills.

Welcome back to the world of quantitative easing.

The drastic swings in the long bond naturally skewed the yield curve:

The yield curve from five to 30 years went from the steepest since October 2017 to the flattest since February 2019, back toward its steepest levels in the span of just a few days. If it wasn’t obvious from the chart, these huge swings don’t happen ordinarily. Usually, bond traders are hypersensitive to moves in the curve because it can suggest relative value opportunities depending on their outlook for the economy and the path of monetary policy.

But when it’s hard to transact, those sorts of bets tend to fall by the wayside quickly. Traders can’t be picky with where liquidity presents itself.

Just to round out evidence of the wild trading in Treasuries this week, consider the 10-year U.S. Treasury Note Volatility Index. It reached a level rivaled only by the one during financial crisis:

If all goes according to the Fed’s plan, the volatility should disappear soon. The central bank will be buying $60 billion of Treasuries “across a range of maturities,” it announced Thursday, “to address highly unusual disruptions in Treasury financing markets associated with the coronavirus outbreak.” It’s unclear if that will be enough — Wall Street strategists have said a better option would be for the Treasury Department to buy back older, less-liquid securities.

One likely reason the Fed acted so swiftly to calm the Treasury market’s malfunctioning is because it serves as the benchmark for so many other securities. Like municipal bonds, for instance:

On Monday, the ratio of 10-year muni to Treasury yields spiked to 150%, the highest level since 2009. That made sense — Treasuries staged a huge rally, and munis fell far behind. Then on Tuesday, as Treasuries sold off, munis moved comparatively less (also as expected), and the ratio fell back toward normalcy.

After that, the going got weird.

On Wednesday, 10-year muni yields rose 27.5 basis points even though Treasury yields rose only slightly. And on Thursday, as Treasury yields fell, muni yields soared by a record 45 basis points, pushing the ratio to 189%, within spitting distance of its all-time high.

“I don’t think anyone knows what’s going on,” Jason Appleson, a portfolio manager for PT Asset Management LLC, told Bloomberg News.

One thing that money managers do know for sure: Investors wanted out of fixed-income funds this week, no matter the type:

U.S. investment-grade debt funds experienced a record outflow of $7.27 billion in the week through March 11, according to Refinitiv Lipper data. Junk bond funds lost $4.94 billion and leveraged-loan funds suffered $2.07 billion of withdrawals. The combined exodus of $14.29 billion is unprecedented, exceeding last week’s record of $12.2 billion.

High-yield muni funds were also particularly hit hard, with investors yanking $1.7 billion, the most since Lipper data begin in 1992.

But back to leveraged loans, which have fallen off a cliff:

The S&P/LSTA Leveraged Loan Price Index fell on Thursday to 88.26 cents on the dollar, the lowest in more than a decade. It’s partly for the same reasons as last week — the loans are floating-rate obligations, which are less appealing when the Fed is expected to drop interest rates to zero. Plus, they’re just risky in general, so they’ll tend to move lower with stocks.

But notably, private equity firms Blackstone Group Inc. and Carlyle Group Inc. reportedly told their portfolio companies this week to do what it takes to avoid a credit crunch, including tapping lines of credit. The two are heavily involved in leveraged finance, so their comments indicate some fear that this turbulent period in markets and the economy could cause some weaker companies to go bust.

That same concern is showing up elsewhere. For instance, the average cost to insure against default on a basket of corporate high-yield bonds is surging:

The Markit CDX North America High Yield Index rose to 443 basis points at the end of last week. That seemed quite high at the time — rivaled only by the risk-off episode in late 2018. The prevailing level now has no rivals. The cost surged to 685 basis points, the highest since data begin in 2007. It has become so extreme, in fact, that Morgan Stanley said credit investors should remove CDX hedges because they’re no longer working.

The investment-grade CDX is also lurching higher. At 139 basis points, it’s the highest since 2011, when it reached as high as 151 basis points. Within the high-grade index, the company-specific credit-default swaps that fared worst include those tied to Royal Caribbean Cruises Ltd., Apache Corp., Hess Corp., Boeing Co. and Carnival Corp.

Meanwhile, trading in the bonds themselves indicates that the reach for yield is over for most investors:

Just about every corporate yield spread has widened to levels unseen since early 2016.

The spread between single-B and double-B junk bonds climbed to 204 basis points. The spread between double-B and triple-B corporate bonds, which crosses the divide between investment-grade and speculative-grade, increased to 264 basis points. The spread between triple-B and single-A bonds widened to 91 basis points.

In December, I questioned what a junk bond even meant anymore when these spreads tightened so drastically. My fellow Bloomberg Opinion columnist Mohamed El-Erian said at the time that investors should buy higher-quality debt. “This is the best up-in-quality trade that exists,” he said. “You don’t give up much yield, and you get a lot more balance-sheet resilience.”

Those who stayed greedy into 2020 are now paying the price.

Many of the credit-market trends in the U.S. extend into Europe. The cost to insure against defaults of the region’s speculative-grade companies is at the highest since 2012, while CDS insuring investment-grade firms is the highest since 2013. The yield spread on a Bloomberg Barclays index of investment-grade European companies surged by the most since 2001 earlier this week.

But arguably the most significant move was in the so-called peripheral sovereign bonds from Spain, Portugal, Italy and Greece after European Central Bank President Christine Lagarde’s most recent decision and press conference:

On Thursday, 10-year yields rose as much as 72 basis points in Italy, the most ever, while they climbed 50 basis points in Greece, 31 basis points in Portugal and 25 basis points in Spain. In what some central bank observers saw as a major slip-up, Lagarde said that the ECB was “not here to close spreads.”

“I didn’t realize the ECB’s primary mandate was to cause a bond market crisis,” quipped Peter Chatwell, head of European rates strategy at Mizuho International Plc. The central bank didn’t lower interest rates, and it announced bond purchases will be focused on the private sector.

The ECB’s decision wasn’t perfect, but it was probably the responsible one. Central banks and governments across the globe are stepping up their efforts to curb the economic fallout from the coronavirus outbreak. Lagarde didn’t need to push interest rates even further negative just to appease traders. Regardless, she still contributed in a big way to the market’s mayhem.

Will it be Fed Chair Jerome Powell’s turn next week? Will the U.S. Congress pass some sort of fiscal stimulus measures? At this point, traders can’t take anything for granted.

To contact the author of this story: Brian Chappatta at bchappatta1@bloomberg.net

To contact the editor responsible for this story: Daniel Niemi at dniemi1@bloomberg.net

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

Brian Chappatta is a Bloomberg Opinion columnist covering debt markets. He previously covered bonds for Bloomberg News. He is also a CFA charterholder.

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