UBS: Bond yields will head higher

The bond rout, which started at the end of last week and has continued into this week has sent shockwaves through the global financial markets.

After months of steadily falling yields, and rising stock prices, volatility has returned with a bang this week. The S&P 500 fell by more than 2.5% on Friday, before rallying just under 1.5% on Monday. The real action has been playing out in the bond markets.

The yield on the 10-year German government bond touched a high of 0.057% Monday morning, according to Tradeweb, and finished at 0.037%, its highest close since late June. In Japan, yields on the 10-year government bond hovered just below zero, up from a low of minus-0.29% in late July. In the U.S., the 10-year Treasury yield was unchanged at 1.671%.

To the casual observer these gains may seem insignificant but they represent yield increases of nearly 100% in the single day for credit instruments that are usually designated as being safe haven assets with little volatility.

Bond yields will head higher
Bond yields will head higher

Bond yields will head higher

The bond sell-off spilled over into equity markets as low yields have been the predominant driver of equity market resilience since Brexit. This is sparked fears of a repeat of the 2013 “taper tantrum” where US Treasury yields spiked leading to fears of a 1929 style crash. Analysts at UBS believe that these concerns are overblow. Indeed, in a flash research note published at the end of last week the bank’s analysts write that it is “unlikely,” the current bond wobble will derail global markets. Specifically, the team writes:

“In our estimates, a full back-up of EUR yields towards fair value and a coincident spike of Japanese yields towards early January levels, would push 10y US yields towards the 1.90-1.95 region (from 1.67% currently). These potential moves are substantial but they should not be seen as a regime change for markets. From a macro standpoint, the global environment remains one of low inflation, low trend growth and accommodative monetary policy. A wobble of 20-30bps in bond markets can also weigh on global equities at this stage, as low yields have been the predominant driver of equity market resilience. However, the deeper the equity damage, the more short-lived the bond sell-off would likely be.”

According to the Swiss bank’s models, from a valuation and a macro standpoint, Euro-area yields look 70bps too low. So, a return to fair value has mentioned above would imply 70bps of upside from Friday’s yields.