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A historic global bond-market crash threatens the liquidation of world’s most crowded trades, says BofA

Global government bond markets are stuck in what BofA Securities strategists call one of their biggest bear markets ever – which in turn threatens the ease with which investors can get out of the world’s busiest trades, if necessary.

Those trades include long positions in the dollar, US tech companies and private equity, said strategists Michael Hartnett, Elyas Galou and Myung-Jee Jung. Bonds are generally considered to be one of the most liquid asset classes available to investors; once liquidity dries up there, that’s bad news for just about every other form of investing, other analysts said.

Financial markets have yet to price the worst-case results for inflation, interest rates and the economy around the world, despite falling global equities and bond sell-offs in the US and UK on Friday. Dow industry DJIA,
-2.48%
were more than 700 points from their lows, flirting with a decline in bear market territory, as the S&P 500 SPX,
-2.67%
threatened to close the end of June.

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US yields hit multi-year highs. Meanwhile, according to BofA Securities, government bond yields in the UK, Germany and France have risen at the fastest pace since the 1990s.

“Inflation/yield/recession shocks aren’t over,” plus the bond crash of the past few weeks “means highs in credit spreads, lows in equities not yet,” BofA strategists wrote in a note released Thursday. They said investor sentiment is “undoubtedly” the worst since the global financial crisis of 2007-2009. The strategists also see that the Fed’s rate target, government bond yields and the unemployment rate in the US will rise between 4% and 5% in the coming months and quarters.

Treasuries have suffered a 20% loss this year, as of Thursday — the worst losses since 1920, according to BofA. For all of 2022, global government bonds are on track for one of their worst performances since the Treaty of Versailles, signed in 1919 and enacted in 1920 – setting the conditions for peace at the end of World War I. Bond prices move in opposite directions, so rising interest rates reflect falling government debt prices.

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Source: BofA Global Investment Strategy, Bloomberg

Liquidity is important because it allows assets to be bought or sold without significantly affecting the price of that security. Without liquidity, it is more difficult to convert assets into cash without losing money relative to the market price.

Government bonds are the world’s most liquid assets, so “if the bond market isn’t functioning, no other market is really functioning,” said Ben Emons, general manager of global macro strategy at Medley Global Advisors in New York.

“Rising interest rates continue to dry up credit and will hit the global economy hard,” Emons said by telephone on Friday. “There is a risk of an ‘all-selling market’ similar to March 2020 as people pull out of markets at greater volatility and discover they can’t really trade.”

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A historic bond sell-off in the UK on Friday, triggered by an erosion in investor confidence fueled by the government’s mini-fiscal plan, only heightened fears of deteriorating liquidity, particularly in the normally safe government bond market.

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In the US, Federal Reserve officials have shown a willingness to break something with higher interest rates – be it in the financial markets or the economy – to mitigate the hottest inflation wave of the past 40 years.

Part of the decline in global bond prices this month “is the real fear that central bank rate hikes are going up in a competitive race to preserve the currency’s viability and not become the last country to run out of pocket. beaten inflation,” said Jim Vogel, an executive vice president. president at FHN Financial in Memphis.

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