Bond investors are shrugging off speculation that the Federal Reserve could raise interest rates soon, reflecting a conviction that rates will rise at an extremely slow pace over the longer term.
Concerns of a big bond selloff prompted by regular rate increases are a distant memory. Fears have also faded that Britain’s vote to exit from the European Union would spur a rush into haven assets and send the yield on the 10-year Treasury note below 1%.
Instead, the consensus view on Wall Street is that yields on longer-term Treasury bonds will barely budge before the end of 2016, as developed economies struggle to produce robust growth, preventing the U.S. central bank from lifting interest rates quickly.
Among five large investment banks surveyed by The Wall Street Journal, the average forecast is for the yield on the benchmark 10-year note to end the year at 1.58%. That is down significantly from the start of the year when Fed officials foresaw as much as four rate increases in 2016 and the consensus view by banks was a year-end yield of 2.68%. The yield closed Friday at 1.597%.
The 10-year note yield initially dropped and then edged higher Friday following the release of an August jobs report that did little to change expectations about the timing of a rate increase.
Yields rise as bond prices fall.
“Even if the Fed does get in a rate hike this year, nobody’s on the page where they think this is going to set off a series of interest-rate hikes,” said John Briggs, head of strategy for Americas at RBS Securities. “It’s not like at this point last year when we thought, oh they’ll go in September and they’ll go once a quarter.”
The Fed last December lifted its benchmark federal-funds rate up from near zero to between 0.25% and 0.5%. But it has refrained from making any moves since then. Despite improvements in the labor market, inflation remains below the central bank’s 2% target, and there has been a debate among economists about whether the Fed needs to fundamentally change its policy-making framework to adjust to a new reality of slower economic growth.
“If yields were to get back to 1.75%, that would probably be sort of generous,” said Tom Girard, the head of New York Life’s fixed-income team, which oversees approximately $140 billion in assets. “There is a healthy amount of skepticism about how strong and vibrant will this recovery really be and how high will the Fed really need to raise rates.”
Other forces are also helping to hold down yields. Low as they are, Treasury yields are much higher than those on many other investment-grade sovereign bonds, where yields have been dragged below zero by aggressive central-bank stimulus.
Although data from the Treasury Department indicates that foreign official institutions, such as central banks, have been net sellers of Treasurys in recent months, most analysts believe that private demand for U.S. debt has more than made up for that pullback, with investors around the globe pouring money into U.S. fixed-income securities in search of safety and better returns than they can get elsewhere.
“If foreign officials are selling, the reason they’re doing that is their economy is looking weak, there’s capital outflows, so they are letting their reserves run off,” said Priya Misra,head of global rates strategy at TD Securities in New York. That in turn suggests a comparatively healthy U.S. economy and strong U.S. dollar, which is attractive to private capital, she said.
Meanwhile, if 2% for the 10-year Treasury yield is looking like a reach, so too is 1%, most analysts say. Just two months ago, falling below that threshold seemed possible in the aftermath of a disappointing May U.S. employment report and the Brexit vote. Since then, there have been three solid jobs reports and a sense that the economic impact of Brexit can be contained.
But a substantial improvement or deterioration in the U.S. economy would change the outlook for bonds, as could policies overseas, analysts say.
Among the catalysts for Treasury yields edging higher recently has been a rise in Japanese bond yields caused by an apparent shift in focus from central-bank stimulus to government spending as a way to bolster the Japanese economy. Some analysts believe that global yields could fall if the Bank of Japan adopts further easing measures; on the other hand, global yields could rise if other countries follow Japan’s lead by embracing fiscal stimulus.
Still, many investors would be quick to scoop up bonds if yields did rise, keeping a cap on increases.
“If we see a backup to 1.75% or higher, we’ll be looking to add, because we think the economy is heading in the right direction, but there are a lot of headwinds still,” said Sean Simko, head of fixed-income portfolio management at SEI, which manages $269 billion.
By: Sam Goldfarb (The Wall Street Journal).
Photo: Economy Finance.
Review: Emerging Market Formulations & Research Unit, FLAGSHIP RECORDS.
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