* Taper talk set to trigger rare annual loss in core bonds
* Return to normal rates has further to run
* Economic impact limited unless rate rise overshoots
By Emelia Sithole-Matarise and Richard Hubbard
LONDON, Sept 11 The global spillover from the
selloff in U.S. Treasuries has buffeted investors in top-rated
governments bonds from Australia to Sweden with more to come if
world growth picks up steam.
Low-risk bond prices have been hammered as the strength of
the U.S. recovery convinces many that the Federal Reserve will
soon start to trim its $85 billion of monthly liquidity
injections, causing large losses for investors.
U.S., Canadian and German bonds are down more than two
percent on a total return basis for the year to date, according
to Citi's latest world government bond index.
If core fixed income markets end this year with losses, it
will be only the third time this has happened in the last 33
years, said major bond investor BlackRock.
"Basically avoid fixed income as much as you can, allocate
to equities, allocate to cash," said Christoph Kind, head of
asset allocation at Frankfurt Trust, which manages 16 billion
euros ($21 billion) in assets.
A move to cut bond purchases by the Fed and the rise in bond
market rates should make bank shares more attractive in
Banks enjoy a bigger margin between the interest they earn
on loans and the interest they pay for deposits when rates are
higher, though the transition to higher rates can be painful,
since bank loans can have fixed interest rates over long periods
of time, whereas deposits tend to re-price more quickly.
UNIFORM RATE RISES
Yields on benchmark U.S. Treasuries have surged by 1.5
percentage points from lows around 1.6 percent in May to top 3
percent for the first time in just over two years.
The equivalent British yields have jumped by a similar
amount over the same period to just above 3 percent. German
yields rose almost a percentage point to top 2 percent for the
first time in 18 months.
The sharp moves have come even as major central banks - the
Fed, the European Central Bank and the Bank of England - have
signalled that official interest rates will stay at record lows
at least for the next couple of years.
Most of the moves are accounted for by a return to more
normal levels to reflect a recovering global economy rather than
a change in central bank rate expectations. This suggests there
might be little central banks can do to fight the trend,
Deutsche Bank strategists say.
It also raises the potential for an overshoot in yields,
especially if the pace of economic recovery beats forecasts or
the Fed reduces its bond purchases more sharply than expected.
Out of nine developed markets, no bond risk premium has yet
returned to its 1997-2012 average even though yields have risen
sharply since the start of this year, Deutsche Bank said.
"Treasury and gilt yields still remain around 50 basis
points below where a normalised bond risk premium would suggest,
while Bunds are even more expensive with another 70 bps still to
go," said George Saravelos, head of European FX and cross-market
strategy at Deutsche Bank.
Yields in other top-ranked bond markets were around 100 bps
below 'normal', implying plenty of scope for normalisation,
according to Saravelos, who said Scandinavian and Swiss markets,
where prices have fallen more modestly since May than in other
developed markets, could have further to run.
"One has to distinguish between cause and effect. Global
bond yields are rising due to a normalising business cycle and
reduced tail risk, so they are the outcome of better growth,
rather than likely to impede it," Saravelos said.
Nevertheless, the surge in global bond yields is raising
concern among European policymakers mindful of the bond markets
crash triggered in 1994 when the Fed started tightening policy.
"If spill-overs were large in 1994, we can expect them to be
even larger today in an even more deeply interconnected world,"
ECB policymaker Jorg Asmussen said in Brussels on Tuesday.
While the euro zone's weaker southern economies have escaped
the sharp backup in yields to date, cyclical shifts in core
long-term rates could delay or even damage the heavy debtors'
ability to manage much needed fiscal reforms.
"Normalising Treasury yields has to be done carefully
because it will dislocate other asset classes, and put serious
stress on the underlying economy," said Bill Street, head of
investments, EMEA, for State Street Global Advisors.
"If you start getting north of four percent for (Treasury)
yields any time soon, you are going to have problems in the real
economy," he said. "Four percent is not out of the realm of
possibility at some point in 2014."