The sell-off in global bonds in recent days can largely be attributed to a rise in German Bund yields due to market concerns over central bank policy.
On Thursday, the European Central Bank (ECB) disappointed markets when it failed to extend its quantitative easing (QE) program.
In addition, Mario Draghi, the president of the ECB, acknowledged that the program was facing a shortage of suitable bonds to buy and internal committees were evaluating possible solutions.
This comes on top of concerns about what the Bank of Japan will do next, with a review of current policy to be announced at its late September meeting.
Australian bonds, along with their US counterparts, have largely been driven by German Bund movements this year and so the sell-off just reflects this fact (see chart below).
In fact, the US 10-year Treasury rate currently has a greater correlation to Bunds (around 90%) than to anything else, including oil and equities.
Australian 10-year bond yields being driven by German Bunds
Source: Bloomberg
The sell-off in Japanese and German long-dated bonds has led to a steepening in global yield curves, reversing some of the flattening we have seen in recent years.
The sell-off in long rates means that investors, already suffering from low rates, will receive a greater yield the longer they invest.
With the recent market sell-off, the yield on the Bloomberg AusBond Composite 0+ Yr Index is around 0.60% over cash.
At this level, it no longer looks expensive-in fact, it is now at the average spread over cash since 2000. As a result, Australian investors are now being compensated for investing in bonds relative to cash at the average rate they would have achieved over much of the past 20 years.
The sell-off in German and Japanese bonds may have further to run given their yields are still around zero, and it is likely to continue to drive global bond markets.
The steepening of the yield curve has seen the yield on the index return to normal relative to cash and any further sell-off should make Australian bonds even more attractive compared with investing in cash.
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