Draghi Sparks Selloff in Global Bonds

By Min Zeng Features Dow Jones Newswires

European Central Bank President Mario Draghi sparked a broad wave of selling in government bonds of the developed world, highlighting investors' vulnerability when major central banks pivot toward a less accommodative monetary policy.

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The center of the selling was government bonds in the eurozone. The yield on the 10-year German bund, the benchmark for the eurozone's debt markets, posted the biggest one-day rise since Dec 2015, according to Tradeweb. Yields rise as bond prices fall.

The selling pressure spread to government bonds in Denmark, Sweden, the U.K. and the U.S., pushing up the yield on the benchmark 10-year Treasury note from its 2017 low set Monday. The yield on the benchmark 10-year Treasury note settled at 2.198%, up from 2.135% on Monday.

Mr. Draghi hinted Tuesday that the ECB might start winding down its large monetary stimulus as the eurozone economy picks up speed, even as he warned against an abrupt end to years of easy money.

The comment surprised many investors because Mr. Draghi appeared to be more hawkish compared with his comment earlier this month, fueling anxiety that the value of government bonds would fall when the central bank starts reduce its monthly large bond purchases.

"It is the risk that policy accommodation may be removed sooner than previously thought, spelling trouble for investors," said Christopher Sullivan, chief investment officer at the United Nations Federal Credit Union.

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The yield on the 10-year German bund rose to 0.37%, the highest close since May 24, compared with 0.249% Monday, according to Tradeweb.

Italy's bond market was the hardest hit with the 10-year bond yield soaring to 2.052% from 1.893% Monday, according to Tradeweb.

The ECB's large bond buying program, along with that from the Bank of Japan, has been a big factor pushing down global government bond yields to their historically low levels over the past few years. The buying has helped keep a lid on the U.S. Treasury bond yields even as the U.S. labor market is approaching full employment and the Federal Reserve has raised interest rates four times since Dec. 2015.

Tuesday's selling reminds bond investors the broad ripples from central bank policies as these banks are becoming a large presence in the world's major government debt market. As the world's financial markets are increasingly correlated and with trading increasingly automated, a selloff or rally in one market easily transmits into other peers.

Investors remember the 2013 taper tantrum in the Treasury market. The 10-year Treasury yield soared after bond investors were spooked by then Fed Chairman Ben Bernanke's comments that the central bank may start reducing bond buying soon. The selloff rippled to other bond markets, pushing up long-term borrowing costs for consumers and businesses and undercut the growth momentum.

The German government bond market led a broad selloff in 2015 when concerns grew over the ECB's bond buying program, showing how vulnerable these haven bond markets -- among the world's most liquid assets -- have become due to unconventional monetary policy. Critics have said that the bond buying program has distorted bond market signals, and investors are finding it hard to put a price tag on bonds' valuation.

Brian Brennan, portfolio manager at T. Rowe Price, said the risk of a tantrum type of selloff is low at the moment. Still, Mr. Brennan said government bonds are rich in valuation and investors tend to "frontrun" central bank policies, which bondholders vulnerable when sentiment sours.

Central bankers have been careful in managing market expectations to avoid another bond market rout that would hurt the broader economy. Fed Chair Janet Yellen said Tuesday that the central bank intends to "very gradually and predictably" shrink its balance sheet, another step in its plan to normalize interest rate policy.

Officials from the ECB and BOJ have been cautious too. So far, top ECB officials have avoided discussing the future of their bond purchases after December, when the program is currently set to end.

Mr. Draghi said Tuesday that the ECB's stimulus policies are working and will be slowly withdrawn as the economy accelerates. However, he warned that "any adjustments to our stance have to be made gradually, and only when the improving dynamics that justify them appear sufficiently secure."

Write to Min Zeng at min.zeng@wsj.com

(END) Dow Jones Newswires

June 27, 2017 16:02 ET (20:02 GMT)