Bond Market Meltdown: 5 Reasons That Explain Why

More than $450 billion has been wiped out across global bond

markets in the past few weeks and, for many people, there doesn't

seem to be any particular reason why. Sovereign-bonds yields had

fallen so far that in order for them to make sense, investors would

have needed to see persistent deflation and European recessions.

For a while, that seemed like a real possibility, as oil went from more

than $100 a barrel to less than $50 and many forecasters were

predicting $30. Well, that didn't happen, and oil started to rise at the

same time as evidence of incipient inflation and economic growth in

Europe.

Introduction

That sparked speculation -- proven to be unfounded -- that the

European Central Bank could even end its bond-buying program

early. Against that backdrop, holding bonds with yields close to zero

made little sense, causing investors to unwind one of the most

crowded trades in all of markets. Here are a few reasons that explain

why.

Introduction (Contd.)

#1

Oil

Bonds became a favorite place to profit from the market turmoil

sparked by crude oil's rapid collapse last year as investor bet it meant

an end to the risk of inflation. Now that the price for crude seems to

have stabilized, and even rebounded, the threat from the main

nemesis of fixed-income investors is renewed.

Oil

Brent Crude Price

#2

Inflation

The rebound in oil may be sowing the seeds of a very good reason

not to own bonds: inflation. Because most bonds' coupon payments

are fixed, rising inflation lessens the value of each one of those

payments in the future. That didn't matter when it looked like falling oil

prices could drag Europe and other parts of the world into deflation,

prompting central banks to cut rates and the ECB to launch its bond-

buying program. Now, all that central bank action, along with the

bounce in oil, may actually be working. Inflation in the euro zone

stopped falling last month after going negative at the end of last year.

Inflation

Euro Area Inflation

#3 European

Growth

The early signs of inflation and positive economic growth coming out

of Europe is causing increased optimism the currency bloc may

actually pull out of its funk. After spending the end of last year

slashing 2015 growth forecasts for the euro zone, economists are

raising estimates again. As recently as February economists were

calling for the euro zone to grow 1.1 percent this year. Now they've

raised their median forecast to 1.4 percent, according to a Bloomberg

survey.

European Growth

Euro Area Growth Forecasts

#4 Positioning

Too many people were invested too heavily in bonds. Data from the

Commodity Futures Trading Commission show investors started 2015

with the biggest bet on U.S. government bonds in seven years. By the

end of the first quarter, more than half that position was gone.

Positioning

U.S. Treasury bond futures long

positions

#5 Sub-Zero

Yields

Between the ECB's bond buying and the threat of deflation, yields

across Europe started to go negative this year, meaning investors

were essentially paying for the privilege to lend their money out. That

created a spillover effect into bond markets in the rest of the world as

investors went in search of a better deal, pulling yields down in those

markets too. The average yield across all Germany's debt went

negative about three weeks ago. That seems to have been the straw

that broke the camel's back. Since then that average yield has

climbed to the highest level this year. Yields on about $2 trillion of

bonds across 12 countries still linger below zero.

Sub-Zero Yields

Bloomberg German Sovereign Bond

Index yields

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