Why bond investors are like bearded dragons

Why the bond market is like a bearded dragon

The defensive tactics employed by sovereign bond investors mirror those used in the natural world by one of its lizards, according to Bryn Jones, the head of fixed income at wealth management firm Rathbones.

A Pogona - commonly called the Bearded Dragon - has a throat that turns black and puffs out if it becomes stressed or is attacked. But if it fails to deter any rival, the reptile would also flee. Jones told CNBC Friday that this had striking similarities to events in the fixed income markets which have seen a selloff in the last few weeks.

"There's been so much volatility around bonds recently that when the bond market sells off, it then attacks and we get a little rally again," he told CNBC Friday.

"This is what the bearded dragon does. As soon as an attacker comes it fluffs up its beard but its next line of defense, you would think it looks kind of nasty, is actually to run away. It has no teeth."

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Benchmark Treasury yields - which move inversely to prices - have seen some major moves in recent weeks after threatening to hit zero earlier in the year. The yield on the 10-year German Bund snapped back sharply to over 0.7 percent in mid-May, although dovish comments from a European Central Bank policymaker this week have helped them to creep lower once more.

The rebound in the price of oil and the anticipation of an interest rate hike in the U.S. has led many to believe that inflation is starting to come back to the global economy. Inflation is usually seen as bad for fixed income markets and good for risk assets like stocks. Analysts like Jones have dubbed this the "reflation trade" and some even believe that the market might not reach the record lows in yields that we saw in April.

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The belief from Rathbones' Jones is that bond market investors will buy into any selloff in bonds, with prices having an inverse relationship to yields, but ultimately will exit if yields shoot too high. However, he believes that sovereign yields won't climb too high and added that the market could soon reach a "tipping point."

"At the moment we've come to a consolidation phase, technically, we've risen very quickly. I think the next selloff that we see, which there will be another one, might get us to where peaking rates might be," he said.

This "peak," he explained, would be where yields start to hurt the global economy and the ability of companies to lend and borrow. It would also be where the yields would be so attractive to investors that they would then start buying bonds again.

German bond yields very nearly tipped into negative territory in April on the back of the aggressive asset purchases by the ECB. Analysts, like Richard Koo, chief economist at Nomura Research, believe that the prices had reached "totally unjustifiable" levels given the fundamentals of the German economy.

"It was the ECB's decision to use QE (quantitative easing) to lower already exceptionally low government bond yields that created a bond bubble," he said.

"And it was the bursting of that bubble that led to the recent events in global markets," he said in a research note this week.

Fixed income investors are right to be cautious at this time of volatility, Jones added, and Rathbones have had a defensive approach for the last year. He explained to CNBC Friday that he has been adding longer-dated bonds to his portfolio at every selloff and when he feels that they have reached "technically oversold levels."

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