Global Bond Sell-off Signals ‘Anomaly’... US Rates Drop but France and Italy Surge - WSJ

[By Myungjeong Sun, Block Media] The sell-off in the global bond market is showing volatility that varies by country. While the US Treasury market has seen a drop in rates (rise in bond prices) due to increased demand for safe assets, bond yields in major European countries like France, Italy, and Greece have surged amid rising fiscal concerns. This, combined with the liquidation of leveraged trades by hedge funds focused on European bonds, is escalating global market anxiety.

According to the Wall Street Journal (WSJ) on the 1st (local time), the yield on the US 10-year Treasury note fell to 5.239% after hitting a 24-year high of 5.292% the previous day. In contrast, bond yields in major European countries rose sharply, drawing a stark contrast to US Treasuries.

Previously, yields on major developed country bonds had shown a trend of rising together, but from this day forward, a clear 'differentiation' began, with funds flowing into US Treasuries and a sell-off in European bonds. Ed Alhusseini, a portfolio manager at Columbia Threadneedle, diagnosed that "signs of a crisis seem to be forming in the market."

US Preference for Safe Assets vs. Volatility Explosion in Europe... France's Fiscal Risk is the 'Key'

The US Treasury market reaffirmed its status as a 'safe asset' despite concerns over high interest rates. Recent robust economic indicators have raised fears of further tightening, but paradoxically, as global uncertainty increased, buying pressure focused on long-term Treasuries. However, US Treasury yields remain at their highest levels in decades, continuing to pressure borrowing costs for businesses and households.

The real issue lies in Europe. The bond markets in France, Italy, and Greece have experienced extreme volatility throughout the day. In particular, the yield on French 10-year bonds fluctuated by as much as 0.16 percentage points in a single day, recording double the usual daily average volatility.

Benoit Anne, Chief Managing Director at MFS Investment Management, explained, "The pressure from rising rates that originated in the overheated US economy is transferring to other countries, leading investors to seek out the 'weakest link' in the global market."

Although the French government proposed a fiscal consolidation plan to reduce next year's spending by about $50 billion and lower the fiscal deficit to 5% of GDP, the market reaction was cold. Benjamin Schroeder, an ING interest rate strategist, assessed that "investors are already looking beyond the announced budget to the political and fiscal instability," adding that "time is not on France's side."

In fact, the spread between the yields on French and German 10-year bonds has widened to 1.4 percentage points, the highest since the eurozone debt crisis. The widening gap with German bonds, the safest asset in the eurozone, is evidence that the market is taking France's fiscal and political risks seriously.

'Hedge Fund Short Squeeze and Forced Liquidation' Fueling Liquidity Crisis

A decisive factor exacerbating this sell-off is the liquidation of leveraged trades by hedge funds.

In recent years, many hedge funds have poured large sums into leveraged trades targeting the price difference between French government bonds and interest rate swaps. While this was a useful source of income when the bond market was stable, losses surged as market volatility spiked.

Particularly, funds with high leverage ratios faced forced position liquidations (margin calls) due to failure to maintain collateral ratios, leading to a sell-off of French government bonds. As liquidity rapidly deteriorated, investors began to realize profits and sell off Italian and Greek bonds as part of risk management.

Blake Gwynn, head of US interest rate strategy at RBC Capital Markets, noted, "The popular long-short structures that were concentrated in the European bond market are all suffering losses and collapsing." Igor Yelnick, founder of Alpidon Capital, also warned that "the current reliance on leverage by funds is much higher than during past crises," stating that "if it coincides with a recession scenario, it could lead to a vicious cycle."

Stock Prices and Euro Drop in Cascade... Attention on ECB Response

The anxiety originating from government bonds has spread like a domino effect to other asset classes. The French CAC40 index fell by 1.6%, while the Spanish and Italian stock markets plummeted by over 2%. The value of the euro also dropped by about 1% against the dollar, falling to the lowest level in over a year at around $1.12.

Outside of Europe, Japan's long-term government bond yields surged to their highest level since 1996 amid massive national debt burdens, causing instability. In contrast, US stocks maintained relative stability, with the S&P 500 rising by 0.2% and the Nasdaq also slightly up, supported by a preference for US assets as safe havens.

The global financial market's attention is now turning to the European Central Bank (ECB). As volatility in the bond market sharply increases, there are rising expectations that the ECB may withdraw its rate hike stance early or intervene in the market. The WSJ predicts that "even if the US Treasury market finds short-term stability, if cracks in the European bond market persist, it could become a ticking time bomb that shakes the entire global financial market."

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