Pacific Investment Management Co. predicts Treasury 10-year yields will be capped near 3 percent into 2015 even with the Federal Reserve beginning to trim asset purchases as early as January.
The manager of the world’s biggest bond fund expects the Fed to reduce its stimulus program in either January or March and depend on tools including forward guidance to keep interest-rate volatility low, said Tony Crescenzi, executive vice president at Newport Beach, California-based Pimco. Benchmark 10-year yields were at 2.80 percent as of 2 p.m. in Tokyo and earlier touched 2.81 percent, the most since Sept. 18.
The gap between 10-year yields and the Fed’s benchmark rate hasn’t widened beyond 4 percentage points over the past half century and the relationship is probably around 3 percentage points now, given the central bank’s policies, Crescenzi said in an interview in Sydney. That will remain true until the Fed funds rate is close to being raised toward the end of 2015 or early 2016, he said.
“The Federal Reserve’s activism equals roughly a percentage point in yield suppression to the 10-year,” Crescenzi said. “We would expect interest-rate volatility to be lower in the next move higher in yield than the last one, because markets have become more comfortable with the notion that tapering is not tightening. And because the Fed has successfully turned attentions to the policy rate.”
The 10-year yield will probably be at 2.75 percent by the end of this year and 3.40 percent by the end of 2014, according to the median forecast in a Bloomberg News survey. The Fed’s target rate will be at zero to 0.25 percent through till the end of 2014, the data show.
“We would expect there to be a limited distance that the 10-year will trade over the Fed funds rate than is normally the case so long as the projection for the policy rate to rise is out in the distant future,” Crescenzi said. “At least through 2015, because the policy rate won’t be raised until late 2015 at the earliest, more likely 2016.”
The central bank has indicated it sees tightened financial conditions with the 10-year yield at 3 percent and comfort as it falls closer to 2.5 percent, he said.
Fed officials signaled they may taper their $85 billion in monthly bond buying “in coming months” if the economy improves as anticipated, according to the record of the Federal Open Market Committee’s Oct. 29-30 gathering, released yesterday. The minutes show extensive discussion on how to increase the clarity of their plans to hold interest rates near zero. They made no decisions on those plans.
“The December tapering looks like low odds,” Crescenzi said. “We would lean toward one or the other; January or March. It’s very data dependent.”
Officials will pare asset purchases to $70 billion a month at their March 18-19 meeting, according to the median economist estimate in a Bloomberg survey on Nov. 8.
Pimco recommends investors avoid longer-dated Treasuries and instead invest in short-term and intermediate maturities that are less affected by rising yields and provide “substantial roll-down,” said Crescenzi.
As a bond nears maturity or rolls down the yield curve, it is valued at successively lower yields and higher prices.
As the Fed’s communication strategy evolves, the success of forward guidance will depend on the decline in the unemployment rate, said Crescenzi.
“To the extent that it falls quicker than markets expect, then the Fed will slowly lose control of the term premium and the ability to suppress longer-term interest rates,” he said.
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