The Demand for Bonds May Backfire

gold-bars-public-domainThe developed market bond yields moved lower in June 2016 as the market focused on the exit by the UK from the European Union.

The bond markets are taking into account the safe-haven demand. The underlying market risk continues to persist and is not expected to fade in the short-term.

The global markets have become extremely volatile in recent times as opinion polls in the UK have indicated that the “leave camp” would prevail in the June 23rd, 2016 referendum.

An exit would signify leaving the 28-nation EU, and solving an array of complex trade agreements that connect the country to the European bloc. The agreements were not easy to create, and they would be extremely difficult to renegotiate.

Uncertainty regarding what the U.K. would have to give up in terms of its access to the continent’s single market has bothered the markets.

Some analysts noted that even if the U.K. votes to continue in the EU, that volatility isn’t likely to pass over easily. The factors around the Brexit are going to remain for some time: the issues around trade & overregulation, the concerns around immigration, and the problems around income inequality.

A Brexit is estimated to hit the U.K. gross domestic product (GDP) by about 2 percent as it weakened the pound, increased inflation and stimulated a housing market correction. That would dent global GDP by nearly 0.1 percent.

The markets are concerned about their incapability to measure the big picture. For e.g., the very survival of Euro.

However, there are other factors that are weighing on bond yields and driving them lower. The Fed’s hiking cycle is expected to be very gradual over the next couple years.

According to Chris Weston, chief market strategist at spreadbettor IG, “A more dovish Fed is not the positive it once was and investors are saying ‘if the Fed are worried then perhaps we should be as well.”

A Japanese Government Bond (JGB) auction on June 16th, 2016 also weighed on yields. Bond prices change inversely to yields.

Declines in oil prices were also impacting bond yields. Lower oil prices result in lower bond yields since oil prices have robust correlations with inflation expectations.

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