Panicked investors sell products linked to US bonds

Record low yields on Treasury notes spook investors in linked structured products

PUBLISHED : Monday, 11 July, 2016, 8:30pm
UPDATED : Monday, 11 July, 2016, 10:55pm

Panicking investors have rushed to cut their losses by selling structured products linked to US Treasury notes, as yields hit record lows of 1.36 per cent.

Treasury notes are bonds issued by the US government that mature in between two and ten years.

One banker, speaking to the Post anonymously, said that a number of private banks had been selling structured products called constant maturity swaps that were linked to US treasury notes.

As long as the benchmark 10-year yields on US Treasury notes does not fall below certain levels, investors could gain five per cent interest on their initial investment.

This investment would be lost, however, if at the end of the contract period US Treasury yields had fallen below the level agreed when the investor bought the product.

“It was a hot seller at the beginning of this year as the US Treasury note yield looked unlikely to drop so low.

“However, some of the contracts expire in August, and last Friday the 10-year US Treasury note yield had tumbled to a record low of 1.36 per cent.

“Some investors have already rushed to sell the contract to cut their losses,” the banker said.

It was a hot seller at the beginning of this year as the US Treasury note yield looked unlikely to drop so low. However, some ...expire in August, and last Friday the 10-year US Treasury note yield had tumbled to a record low of 1.36 per cent
Unnamed banking source

The banker said that if US Treasury notes were to bounce back to above 1.4 per cent when their contracts end in August, many investors would not suffer losses. Investors are not confident that this will happen, however.

“Investors are panicking and there are some who have already sought to sell the contract on, even though they could only get a a low price,” he said.

Because US Treasury bonds are generally perceived as being the safest assets in the world, investors tend to flock to them in times of concern over the global economy.

As the amount a bond pays out is fixed, if prices go up, the amount an investor receives, in percentage terms (the yield), goes down.

“The recent sharp downward movement in US Treasury yields is reflective of flight to quality and also expectations that central banks will stay accommodative given the political and economic uncertainty post the Brexit vote,” said Rishabh Saksena, head of investment specialists Asia at Bank Julius Baer.

After the UK voted to leave the EU last month, British and European markets have been particularly volatile, though those around the world have also been affected.

At one point the Hong Kong stock exchange was down 1,000 points.

The uncertainty means the Bank of England is likely to lower interest rates in the coming months, and other central banks around the world will keep theirs at low levels. A rise in interest rates would cause bond prices to fall.

“The record lows in US Treasuries at almost anytime other than today would be very concerning and would portend looming disaster,” said Brett McGonegal, chief executive at Capital Link International.

“However, when compared to yields of its peers it elicits a different response.

“With record low yields across the world and negative rates in Japan, US treasuries almost seem like a good investment. Flight to safety continues to be the impetus setting yields and there will not be a drastic reversal anytime soon.”

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