Government bond woes trigger broad market turmoil

Investors intensified their selling of government bonds on Tuesday, knocking eurozone share prices, while emerging markets also experienced significant pressure.

Concern that long-dated bond yields are low and provide meagre protection against the prospect of higher inflation, has driven the shift out of what was a winning trade for much of the past year.

After a sharp rise in US Treasury yields on Monday, investors exited benchmark bond markets in Asia and Europe on Tuesday, with rising market volatility rippling across equities and currencies.

The renewed selling comes after hefty downward pressure on government debt prices in recent weeks, with rising oil prices fanning inflation expectations. That raised the prospect of investors making a big allocation shift out of the bond sector that could potentially spark broader market turmoil.

Justin Knight, fixed-income strategist at UBS, said the global bond market sell-off is "a continuation of the shake-out of positions, but markets have also moved closer to reality in terms of economic growth and inflation. The path of least resistance now for yields is upwards."

The US 10-year Treasury yield rose to 2.35 per cent in London trading, its highest level since November. The benchmark borrowing rate has been rising steadily since bottoming at 1.85 per cent during April.

The German 10-year Bund yield was 10 basis points higher at 0.71 per cent, with the benchmark UK gilt yield up 8 bps at 2.03 per cent, a level last seen in November. Other key eurozone bond benchmark yields, including Spain, Italy, Netherlands and France were also higher.

Euphoria over the European Central Bank's €60bn-a-month monetary stimulus that pulled the German 10-year bond yield down towards zero per cent last month has faded on improving growth prospects and climbing inflation expectations.

US Treasuries have been vulnerable since Federal Reserve chair Janet Yellen last week signalled they were overvalued. Bond investors are also concerned that the central bank may not tighten interest rate policy this year, and that means long-dated bonds are vulnerable should inflation shift higher in the coming months.

Lyn Graham-Taylor, fixed-income strategist at Rabobank, said: "It [the sell-off] is starting to stretch the boundaries of what you could call a technical correction. A lot of strategists are getting nervous."

In turn, eurozone equities were flashing red, while US equity futures were also appreciably lower ahead of opening in New York. Germany's Dax index was 2.2 per cent lower, while the broad FTSE Eurofirst 300 index was down 1.8 per cent.

Financial stocks were among the biggest fallers across Europe, along with industrial stocks and big exporters.

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