A financial trader walks across the trading floor inside the Frankfurt Stock Exchange in Frankfurt, Germany, in this file photo.Ralph Orlowski/Bloomberg
If this week's wild debt-market ride offers any indication of what's to come, bond investors ought to steel themselves for an unusually turbulent second half of the year.
A global bond sell-off under way for weeks briefly turned into a rout, as panicked investors dumped triple-A-rated German bunds, U.S. Treasuries and other government debt, before abruptly reversing course Thursday afternoon. And analysts say such instability is bound to become a regular feature of a once-complacent market as concerns mount about everything from a Greek default and mispriced risk to a lack of liquidity, amid other distortions stemming from aggressive monetary easing combined with continued weakness in key economies.
Whether it was the Greek mess, a long overdue correction, fears that the European Central Bank's policies are stoking too much inflation or ECB chief Mario Draghi's blasé approach to market volatility, investors reacted in stunning fashion.
"It's definitely been a dramatic move," said Mark Chandler, head of Canadian fixed income and currency strategy at RBC Dominion Securities Inc. "But our view is that it came from quite stretched levels. There's reason to expect that yields will continue to rise from these levels."
The 10-year German bund, recently labelled the "short of a lifetime" by bond legend Bill Gross, behaved that way Thursday as the yield shot up toward 1 per cent in triple its normal trading. Yet there was little new information underpinning the sell-off.
"We have no excuses other than the old saw of price action begetting price action," said David Ader, head of government bond strategy with CRT Investment Banking LLC. "So we are forced to go back to Draghi and his inspiration for more of the European taper tantrum."
Before recovering lost ground later in the trading day, the euro zone's benchmark bond suffered its worst two-day drubbing since prior to the advent of the euro in 1999. As recently as mid-April, the 10-year bund was yielding a record low 0.05 per cent.
Ten-year U.S. Treasuries also reached their highest level of the year, as the International Monetary Fund urged the Federal Reserve to hold off on any interest-rate hike until the first half of next year. This "would provide valuable insurance against the risk of disinflation, policy reversal and ending back at zero policy rates," the IMF said in its annual review of the U.S. economy.
The IMF advice followed a similarly downbeat assessment on Wednesday of U.S. and global economic growth prospects by the Organization for Economic Co-operation and Development.
The same day, Mr. Draghi had this to say about market conditions: "We should get used to periods of higher volatility" because that's what happens to asset prices "at very low levels of interest rates."
But he pointedly added that this would have no effect on the central bank's monetary policy.
The sell-off accelerated in the wake of his remarks.
The Canadian market has so far avoided the worst of the upheaval experienced in Europe and the United States. But RBC sees longer-term yields climbing another 50 basis points in both Canada and the U.S. by the end of the year.
"We won't quickly get back to yields of 4 to 5 per cent," Mr. Chandler said. "But to expect us to rewind what we saw in the last six to eight weeks is wrong."
Central banks have been "complicit" in the sell-off, he said, because several took advantage of lower world oil prices and higher headline inflation to cut interest rates.
"For them to have piled on as they did exacerbated the rally that we saw in the first couple of months this year. Now that oil has sort of stabilized and turned the other way, they're almost living by the sword and dying by the sword."