European, U.S. Bonds Slump as Hedge Funds Seen Selling to Offset Losses
U.S., European Bonds Drop; Hedge Funds Seen Selling (Update2) (Updates prices.)
New York, Oct. 9 (Bloomberg) -- U.S. bonds tumbled for a fourth day, rounding out the worst week since July 1996, amid speculation hedge funds were selling bonds to offset losses in other markets. ''We're seeing an unwinding of all the trades'' that pushed bond yields to historic lows, said Margo Cook, who helps manage $18 billion in bonds for the Bank of New York. ''People are running for the hills.'' Cook started selling Treasury securities Monday, when 30-year yields fell to a three-decade low.
The 30-year Treasury bond, a bellwether for global bond markets, fell 1 27/32 points today, or $18.44 per $1,000 bond, driving its yield up 11 basis points to 5.11 percent. The yield is up 39 basis points since Monday.
At the Chicago Board of Trade, the December bond futures contract tumbled as much as 3 points, triggering trading limits for the first time since March 6, 1996. No further trades are allowed below that price, though trading isn't halted.
European debt markets also plunged. Ten-year German bund yields rose 13 basis points to 4.22 percent. Ten-year U.K. gilt yields rose as much as 50 basis points, later paring the increase to 33 basis points and closing the day at 5.18 percent.
Today's 22 basis point jump in yield on 10-year U.S. notes was the largest one-day increase since July 5, 1996. They yield 4.78 percent, or 398 basis points more than the 0.80 percent yield on the No. 203 benchmark 10-year Japanese bond, and 56 basis points more than 10-year German bonds.
U.S. bond yields are now where they were two weeks ago. The last time yields jumped so much in a week was in July 1996, when a strong-than-expected employment report ignited concern the Federal Reserve would boost interest rates.
Treasury bills fared better as investors sought the safest investments. Yields on six-month bills fell 10 basis points to 4.05 percent on a bond-equivalent basis.
Rally to Rout
The rout in longer-term Treasuries spells an end, at least for now, to a year-long rally that drove 30-year yields down almost 1 3/4 percentage points to a 31-year low of 4.69 percent on Monday. That run was sparked and sustained by economic and financial turmoil in Asia and Russia, and by declines in stock markets from Tokyo to Frankfurt to New York.
The appeal of Treasuries as a refuge grew in recent weeks as Long-Term Capital Management LP's near collapse caused investors to shun riskier fixed-income securities.
Yet the reversal gathered momentum Wednesday, when the dollar registered its biggest decline against the Japanese yen since 1973. That prompted investors, many of them hedge funds, who had borrowed at Japan's record-low interest rates and invested in Treasuries, to rush for the exits. ''People have decided that the party is over.'' said Lee Cohen, co-manager of the primary dealership at CIBC Oppenheimer Corp. ''There's a lot of hedge fund trades being unwound and that's putting a lot of pressure on the Treasury market,'' said Eric Cheung, who oversees about $2.8 billion at Wilmington Trust Corp. in Wilmington, Delaware.
A yen-based investor who at Dec. 31 bought a basket of Treasuries maturing in one year or more reaped returns of about 15 percent as of last Friday. Today, those investors are sitting on a loss of about 1 percent on the same investment. Japanese investors were among today's sellers, traders said.
The Fed
The difference in yields between U.S. notes and bonds, known as the yield curve, ''steepened'' this week, returning to a level closer to historical norms. Yields on 30-year bonds are 94 basis points higher than those on two-year notes. That is closer to the average of 122 basis points over the past seven years and up from the recent low of 12 basis points seen on June 23.
The steeper yield curve, in this case, suggests that investors are expecting more rate cuts from the Federal Reserve.
Many traders expect the Fed will cut rates before its next policy meeting, on Nov. 17, to ease investor concern and avoid a credit crunch. That would be a big shift for the Fed, which has only changed interest rates at meetings of its policy committee since April 1994. ''Fear is running through the bond markets, liquidity has disappeared,'' said William Lloyd, head of market strategy at Barclays Capital Inc. He said the Fed could cut rates at any time.
Eurodollar rates, a key indicator of interest-rate expectations, suggest the Fed will cut rates by about 75 basis points in the months ahead.
The rate on 90-day Eurodollars for March delivery was 4.52 percent, compared with a current rate of 5.34 percent on three- month overnight borrowing rates. This futures contract on dollar- denominated bank deposits outside the U.S. is one of the credit market's most sensitive indicators of U.S. rate expectations.
The central banks of Portugal and Ireland cut rates today, following moves earlier this week in the U.K., Denmark and Spain.
The Fed cut its target rate for overnight loans between banks by a quarter percentage point to 5.25 percent last week, its first change rates since March 1997. 'Unprecedented'
Investors said it was difficult to get securities firms to make bids on some European government debt, which is typically considered among the most easily traded in the world. That made the slump in prices worse. ''This is unprecedented,'' said Paul Thursby, who helps oversee about $10 billion of bonds at Baring Asset Management in London. ''Hedge funds are trying to sell everything, including top quality bonds which they presumably held as collateral'' for other investments.
Analysts said concern hedge funds would have to sell more of their government bond holdings to offset losses in emerging markets and in currency markets following the recent slide in the dollar against the yen also hurt bonds.
Many hedge funds lost money recently amid tumbling currencies and stocks in emerging markets, with this week's slump in the dollar adding to losses for some. Julian Robertson's Tiger Management, for example, lost 9 percent of net assets Wednesday, or almost $2 billion across all its funds, two investors said.
Swap Markets
The benchmark five-year U.S. dollar swap spread widened 1 basis point to 88 basis points, just off a 10-year high. The spread is the difference between the yield on the benchmark Treasury and the highest rate at which a ''AAA''-rated corporation can sell its fixed-rate bonds, if it wants to do a swap that leaves it paying no more than the London interbank offered rate.
Corporations often use interest-rate and currency swaps to guard against changes in interest rates. The banks and securities firms that provide these swaps often buy or sell U.S. Treasury securities to hedge against a rise in interest rates.
About $48 billion in Treasuries traded through most of the major bond brokers as of 2 p.m. Eastern time, according to GovPX, Inc., a bond pricing service. Volume was about average for a Friday in the past month and 2.7 percent above the average Friday of the fourth quarter of 1997, GovPX said.
Trading halted an hour early in the cash and futures market, and the market will be closed Monday for the Columbus Day holiday.
The so-called basis, which reflects the difference between the current 30-year bond and the December futures contract, widened 4/32 to 462/32, or 14 14/32.
The December Treasury bill contract rose, sending its yield 3 basis point lower to 3.86 percent, while the December Eurodollar contract's yield fell 3 basis points to 4.88 percent.
The gap between the two, the so-called TED spread, was steady at 102. The TED spread is an indication of investor confidence in the U.S. financial system.
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