Investor flight from U.S. stocks fails to lift bond market

Fri Sep 4, 2015 6:41am EDT
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By Gertrude Chavez-Dreyfuss

NEW YORK (Reuters) - The "flight to safety" into bonds many expected when U.S. stocks slumped last week never took off, making big losers out of prominent fund managers and further confusing investors at a volatile time in the market.

Stocks plunged in the second half of August, largely on fears of China's worsening economy, but U.S. Treasury yields did not see the kind of safety bid that many were expecting and has been typical in times of stock-market stress in the past.

Strategists link the lack of a move to bonds to a number of events: Hawkish rhetoric from Fed officials even as the equity market stumbled; a bout of selling by hedge funds that had expected a rally in the bond market that they didn't get; and bond sales by central banks in China and other emerging market economies trying to protect their currencies from depreciating.

Reduced appetite from overseas, along with the outlook for the Fed, will be crucial in coming weeks if equities fall again and bonds don't respond. The Fed decision on September 17 could mark the first rate increase in almost a decade, and uncertainty surrounding that decision is likely to keep many in the bond market on the sidelines.

"The correlation between bonds and stocks is more situational now because it's the central banks calling the shots," said Robert Vanden Assem, head of developed markets investment grade fixed-income at PineBridge Investments in New York.   

During the recent U.S. stock market sell-off in the third week of August, for instance, the S&P 500 .SPX dropped 9 percent, but U.S. 10-year Treasury yields, which move inversely to prices, fell by only 12 basis points.

That's not typical. According to Bank of America Merrill Lynch, the relationship between stocks and bonds that has held since 2009 suggests 10-year yields should have declined by 22 basis points.

Bond yields since then have drifted higher and buying interest has been minimal. The lack of a rally in the U.S. Treasury market made big losers out of notable hedge funds, including Bridgewater Associates' All-Weather Fund, which fell 4.2 percent in August.   Continued...

A trader works on the floor of the New York Stock Exchange shortly after the market opened in New York September 1, 2015.  REUTERS/Lucas Jackson