Bonds take a battering as investors embrace cash

Global bond markets succumbed to savage bouts of selling yesterday as investors shrank from anything that smacked of risk and sought the safest of havens - cash.

Prices fell sharply as hedge funds unwound their positions in the bond markets, ending a sustained bond rally that has coincided with turmoil in emerging markets.

The slide in bonds with longer maturities followed the dramatic fall in the US dollar against the Japanese yen on Wednesday and Thursday, which shook investor confidence. The dollar steadied yesterday at around Y117, compared with more than Y130 at the beginning of the week.

Fears of a possible credit crunch and jitters about the health of banks have prompted nervous investors to try to liquidate longterm assets. But an acute lack of liquidity meant that most were unable to do so yesterday, with price movements exaggerated by the few large trades that made it through.

Sharp reversals were also seen in Europe. In Dublin, traders said that the market could not escape the global mood and prices have fallen sharply and yields or longterm interest rates risen in nervous trading. The yield on the benchmark 10 year stock has risen from 4.159 per cent on Wednesday to 4.569 per cent yesterday.

Traders said there was a dramatic shift away from longer-dated bonds and towards short-dated stock, which typically offers a return closer to that of cash.

The benchmark UK government bond future was down 4.24 points at one stage, ending the day 2.69 points lower at 113.65.

Only a week ago, investment in high-quality government bonds was considered protection against a significant downturn in the global economy and nervousness in equity markets.

But in the space of about 48 hours, that image has been punctured. Investors, increasingly concerned about the global financial crisis, have become extremely risk-averse and banks are trimming credit lines.

The risk that credit lines may be cut means it is becoming harder for companies to finance projects and many are realising their investments including bond positions they may have held for some time.

Hedge funds are also desperate to off-load bond holdings to cover losses in emerging markets, unwind currency holdings and repay loans raised to speculate in the markets.