Don’t bet against the U.S. bond market rally anytime soon.
Conflicts in Ukraine and the Middle East, and record low bond yields in Europe, have unleashed a stampede into Treasuries, knocking benchmark 10-year yields to 2.30 per cent, a 14-month low at one stage on Friday. They ended the week at 2.34 per cent.
The U.S. bond rally, which accelerated on Friday after Ukraine claimed its artillery destroyed part of a Russian armoured column that entered its territory, has shown earlier market calls from some leading bond investors, such as DoubleLine’s Jeffrey Gundlach, to be on the money.
“We are in a market environment now that is largely beyond fundamentals,” said Chris Orndorff, portfolio manager at Western Asset Management in Pasadena, California, a leading U.S. bond manager that has about $US470 billion in assets. “The falling yield levels are a reaction to panic, as U.S. Treasuries continue to play the role that they have always played, the favourite asset in a flight-to-quality environment.”
U.S.-based funds that invest primarily in Treasuries have attracted inflows for four straight weeks, accumulating more than $US4.5 billion of new investor cash in that run, according to Lipper, a unit of Thomson Reuters. The four-week moving average of flows shows investors moving into this sector at the fastest pace in nearly six months.
Meanwhile, more speculative investors such as hedge funds, have reversed their recent short positions in 10-year Treasury futures and options. The latest week’s Commitments of Traders data from the Commodity Futures Trading Commission showed speculators were net long by about $US374 million after being net short by $US616 million the week before.
The latest bull run in bonds has defied expectations of those traders and investors who had bet on U.S. interest rates rising this year as the U.S. jobs picture improved and the U.S. Federal Reserve paved the way to tighten policy in 2015.
Bond yields could decline further if, as expected, Fed Chair Janet Yellen reiterates her concerns about underlying weakness in the labour market in her speech next week at a global central bankers conference in Jackson Hole, Wyoming.
“She is going to remind us why they would maintain a dovish policy stand,” Jeffrey Rosenberg, chief investment strategist for fixed income at New York-based BlackRock, the world’s biggest asset manager with $US4.3 trillion in assets.
Bond analysts and managers interviewed by Reuters on Friday said the 10-year yield could fall another 10 to 15 basis points. They didn’t rule out it reaching the 2 per cent level in the current rally.
Still, they warned that if global political tensions ease, the safe-haven demand for U.S. bonds will subside. Then, the 10-year yield could snap back to 2.60 to 2.70 per cent.
ROCK-BOTTOM EUROPEAN YIELDS
Foreign demand for U.S. Treasuries has also grown in recent weeks because the yields on German and other European government bonds continue to fall.
The benchmark 10-year U.S. Treasuries yield has been running more than 1.30 percentage points above the yield on 10-year German Bunds since the beginning of July. This premium is the biggest since June 1999, which was before the euro was introduced.
Some big bond investors like Pimco’s Bill Gross, who manages the world’s biggest bond fund <pttrx.o> with $US223 billion in assets, see Treasuries gains tied closely to the movement in Bunds. That’s because the consistently wide spread between the two makes it an attractive carry trade for European-based investors to sell Bunds and buy Treasuries. With the euro declining, investors would also get a positive currency benefit.
This week, data showing anemic second-quarter growth across the eurozone, suggesting the 18-nation block is close to deflationary conditions. The European Central Bank is expected to fight aggressively to prevent deflation from taking root by providing more easy money, which in turn could see European bond yields fall further.
“European government bond pricing is reaching an inflection point, which will force the ECB to act,” said Larry Jeddeloh, chief financial officer of the TIS Group, which produces the Market Intelligence Report.
This week, the German two-year yield <de2yt=rr> fell into negative territory while its 10-year yield <de10yt=rr> dropped below 1 per cent for the first time ever. Italian and Spanish yields fell to record lows in step with their German counterparts. [GVD/EUR]
“This pulls global allocation into the United States,” BlackRock’s Rosenberg said.
He said that Asian investors dealing with a stuttering Japanese economy and fears of slower growth in China had been shifting more money into U.S. debt.
The yield on 10-year Japanese government bonds <jp10yt=rr> ended Friday at 0.51 per cent, 1.83 percentage points below the 10-year U.S. yield.
(Reporting by Richard Leong; Editing by Dan Burns and Martin Howell)
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