El Erian Warns About Sovereign Bond Volatility in 2015

Sovereign bonds have been full of surprises this year: From the U.S. to Spain, yields are declining further after confounding investors’ expectations by staying low for most of 2014. It’s a trend that could be setting markets up for greater volatility in 2015.

The level of interest rates is truly remarkable. Who would have predicted that toward the end of the year, U.S. 10-year Treasury bonds would yield only 2.12 percent, German bunds only 0.62 percent or Japanese 10-year bonds only 0.37 percent? Even more financially challenged governments, such as Italy, Portugal and Spain, have seen yields fall to record lows.

The trend has three main drivers. First, with the exception of the U.S., almost all the systemically important economies have seen their growth projections deteriorate. The International Monetary Fund’s forecast for global growth in 2015 now stands at 3.2 percent, down from 3.9 percent a year ago.

Second, inflation projections have come down, and will probably fall further given the sharp drop in oil prices. Declining oil prices will reduce the cost of products for which energy is a major input, and — on the margin — will encourage central banks worried about deflation (such as the European Central Bank) to keep monetary conditions looser than they otherwise would.

Third, many investors have stayed away from U.S., German and Japanese government bonds or even bet against them, on the expectation that yields would rise and prices would fall. As the market has gone in the other direction, they have been forced to buy bonds to get out of their positions. The October “flash crash,” in which U.S. Treasury yields fell to less than 2 percent, flushed out quite a few of these investors — but far from all of them.

via Bloomberg

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Alfonso Esparza

Alfonso Esparza

Senior Currency Analyst at Market Pulse
Alfonso Esparza specializes in macro forex strategies for North American and major currency pairs. Upon joining OANDA in 2007, Alfonso Esparza established the MarketPulseFX blog and he has since written extensively about central banks and global economic and political trends. Alfonso has also worked as a professional currency trader focused on North America and emerging markets. He has been published by The MarketWatch, Reuters, the Wall Street Journal and The Globe and Mail, and he also appears regularly as a guest commentator on networks including Bloomberg and BNN. He holds a finance degree from the Monterrey Institute of Technology and Higher Education (ITESM) and an MBA with a specialization on financial engineering and marketing from the University of Toronto.
Alfonso Esparza