Missing in action: 'Lobotomised' sovereign bonds sit out Trump-induced volatility

LONDON (Reuters) - In all the market volatility sparked by news of President Donald Trump’s positive COVID-19 test, one asset was noticeably absent: top-rated sovereign bonds, the securities investors most rely on to counterweight equity losses.

The failure of U.S. and German government bonds to rally much on Friday despite a selloff on European equities and U.S. stock futures will further test their reputation as “safe” assets, which not only hold no risk of default but also strengthen in times of trouble.

Earlier this year when coronavirus panic gripped markets, bond yields did fall, meaning their prices rose. Since then though, sweeping interest rate cuts and trillions of dollars in central bank money-printing have dulled their ability to react.

(Graphic: No more room to fall? Safe-haven yields and risk off - )

Friday appeared to cement that view - investors did not rush to buy bonds that are already exorbitantly priced after hefty stimulus - more than 60% of the euro zone sovereign debt carries negative yields, and U.S. yields have slid more than 100 basis points this year.

“It confirms that the attraction of government bonds as a diversification tool has been significantly reduced by the coronavirus crisis,” said Francois Savary, chief investment officer at Swiss wealth manager Prime Partners.

“So, if investors are retrenching from equities because of risk-off, they are absolutely not putting money into bonds.”

These assets are of course safe in so far as they will never default; what’s in question is their ability to strengthen when things turn sour.

U.S. 10-year Treasury yields stood at 0.66% US10YT=RR, down one basis point for much of the European session. German Bund yields slipped a similar amount to -0.55% DE10YT=RR.

Savary prefers gold as a diversification tool, having upped exposure to around 8% from 5% this year.

Indeed gold, which surged to record highs above $2,000 an ounce XAU= earlier this year, seems to be the one beneficiary of fund managers' reluctance to load up further on low or negative-yielding sovereign bonds.

Now weak economic data, Trump’s infection and election risks may force further central bank intervention, especially as inflation remains weak. Euro zone inflation was at four-year lows at minus 0.3% in September, data showed.

It means central banks may further tighten their grip on bond markets. Holding a third of German debt and more than 40 percent of Japan’s, they have effectively “lobotomised” bond markets, says Mike Kelly, head of multi-asset at PineBridge Investments.

“In the last month, we have all been disappointed that during risk-off days, the yield curve has been like a zombie. There is a lot of soul searching going on (regarding safe havens)...We need a longer dated government security that will trade as a safe asset.”

(Graphic: Market Volatility - )


So the conundrum for portfolio managers: In a world full of risk, where to seek security?

Aside from gold, investment grade-rated corporate bonds can be an effective hedge, said Seema Shah, chief strategist at Principal Global Investors.

“You get a (yield) pick-up and the central bank backstop means it is relatively safe,” she said, referring to policymakers buying corporate bond for stimulus.

It may be that Trump’s infection is not in itself a big enough trigger for a bond rush.

Cyril Regnat, head of research solutions at Natixis in Paris, says U.S. Treasuries are more likely to break out of narrow trading ranges as the Nov. 3 election day gets closer.

And after the upheavals of this year, it might take a much bleaker assessment of global growth prospects to trigger moves.

“The threshold for what is considered a crisis is a bit higher than what it used to be,” Principal’s Shah added.

Reporting by Dhara Ranasinghe and Sujata Rao with additional reporting by Yoruk Bahceli; Editing by Mark Heinrich