Why did bond prices drop by more than 20%, a true all-time high? Within a few months, the reference rate (formerly the discount rate) of the US Central Bank climbed from zero to 2.25%. For now, the Eurozone strategy is softer, because the analogous rate has risen from zero to 1.25 per cent. It is not automatic that the restrictive policy of the ECB follows that of the Fed. It will depend on the evolution of the cost of living on both sides of the Atlantic. But not only the march of rates to raise prices. At the same time, a substantial part of international operators in the financial sector, through the use of futures, derivative instruments, and algorithms, sells the aforementioned futures shortto then buy them back at significantly lower prices, when they believe that their price will have reached the minimum values that they had set at the time of sale.
The mechanism of long titles
It should be borne in mind that, against the rise of one point in the market yield, the price of a ten-year bond, a BTP with a maturity of 2032 for example, falls on average between 8.5 and 9 points. A retreat in market value not unlike what occurs in the equity sector. In light of this (theoretical) indication, the decline in the value of a ten-year BTP should have been around twelve points, because the reference rate rose to 1.25%. In reality, the decline was higher, because, as anticipated, nothing prevents the level of the ECB rate from reaching that of the Fed.. And, at the current value of the Washington reference rate, the drop in the price of the ten-year issue is close to 20%. In light of this hypothesis, those who use derivative instruments set their strategy on the one that, in their opinion, should be successful. Even if it assumes non-negligible risks.
The volatility is not only of this crisis
A reasoning less linked to the speculative component, which is always present in this type of activity, could refer to what had occurred in recent years. The listing of the BTP with maturity 15 September 2032, gross coupon equal to 1.25 per cent, reached 118.39 at the end of October 2021 for a gross yield of 1.14%. Now the yield itself has risen, on the back of this chaotic phase to 4.21 percent. But it was just under 3.50 per cent in October 2018. This latter level is more in keeping with the risk / return ratio of our country’s government issues with a ten-year maturity. The fall in the prices of instruments traded on the financial markets is repeated fairly frequently. As happens with real estate, gold and other instruments, not least Bitcoins. It is not to be excluded that the continuous and substantial increases in the reference rates will end up bringing the Eurozone, but also the United States, into an economic recession. At that point, the monetary policy of the Central Banks will change from restrictive to expansionary. And, with the change in monetary policy itself, the decline in the prices of fixed coupon securities will also leave room for a general rise.