Global bond returns may have nowhere to go but down after the best first half since 2005.
Investors who piled into Treasuries, bunds, gilts, and Japanese bonds on concern that Europe’s sovereign-debt crisis would derail global growth are finding the securities less appealing with yields at about the lowest on record. The emerging bearishness may be most apparent in the $4.3 trillion-a-day market for U.S. Treasury repurchase agreements, where no maturity commands a premium.
That’s a switch from a year earlier, when investors resorted to paying interest to borrowers while lending cash just to obtain Treasuries after the worst finance crisis since the Great Depression. None of the securities are what traders call on “special” in a sign that investors don’t expect Europe’s sovereign debt crisis will curb the global economic recovery, according to data from GovPX Inc., a unit of ICAP Plc, the world’s largest inter-dealer broker.
“No one’s freaking out,” said Jason Brady, a managing director at Thornburg Investment Management in Santa Fe, New Mexico, which oversees $59 billion. “It’s definitely a much more situation normal indicator than what we saw a couple years ago when it was a horror show. As we’ve gotten to lower yields in Treasuries, they’ve gotten less interesting.”
Treasury 10-year note yields, the benchmark for everything from mortgages to corporate bonds, will climb to 3.74 percent by year-end from 3.11 percent on June 25, based on a Bloomberg survey of forecasters. That would imply a loss of about 3.26 percent as yields rise and note prices fall, according to data compiled by Bloomberg.
The 10-year note yielded 3.04 percent at 9:57 a.m. in New York.
Higher yields are also forecast for German bunds, U.K. gilts, Japanese bonds and debt from the rest of the Group of Seven nations, separate surveys of economists and strategists by Bloomberg News show.
Government debt is “our least-favored segment of the bond market,” a team of strategists led by Jeff Applegate, who oversees about $1.8 trillion as chief investment officer for Citi Global Wealth Management in New York, said last week in the firm’s Global Investment Committee Monthly report for June. “We expect to see higher yields once investor risk aversion recedes, causing this sector of the bond market to underperform.”
Leading the Gains
The benchmark 10-year Treasury note has returned 7.85 percent this year, including reinvested interest, leading global government bonds to a gain of 3.36 percent, according to Bank of America Merrill Lynch indexes. That’s the best start since the firm’s broadest sovereign debt index rose 3.77 percent in the first half of 2005.
Sovereign debt yields dropped to 2.10 percent on average last week, within 3 basis points of the low of 2.07 percent reached on May 25, based on the firm’s Global Sovereign Broad Market Plus Index. The gauge tracks 1,165 bonds with a market value of $18.6 trillion.
Predicting higher yields has been a losing bet. At the start of the year, the median estimate of 67 economists and strategists surveyed by Bloomberg News was for 10-year Treasury rates to rise to 3.9 percent by now.
Instead, slower inflation, worsening government finances in Europe and concern that Greece will default on its debt and send the global economy into another recession led investors to seek the safety of bonds issued by G-7 nations. The MSCI World Index of stocks has fallen 7.44 percent this year.
Federal Reserve policy makers won’t raise interest rates until the first quarter of next year, based on the median estimate in a Bloomberg survey of economists this month.
After leaving its target rate for overnight loans between banks in a record low range of zero to 0.25 percent on June 23, the Fed said in a statement that “financial conditions have become less supportive of economic growth on balance, largely reflecting developments abroad.” It also reiterated that it will keep rates low for an “extended period.”
“We need to really get some solid ground under us” before central banks tighten monetary policy, said David Ader, head of government bond strategy at Stamford, Connecticut-based CRT Capital Group LLC. “I don’t think people are willing to make bets right now.”
Low yields are helping governments finance their budgets deficits more cheaply. The administration of President Barack Obama spent $248.2 billion in interest expense in the first eight months of fiscal 2010 ending Sept. 30, up 16 percent from $214 billion in the same period of 2009 even though the amount of market debt outstanding rose 23 percent to $7.96 trillion, Treasury figures show.
While reports last week showed housing sales in the U.S. fell, other data indicate concern the economy will slow may be overblown. The Thomson Reuters/University of Michigan index of consumer sentiment increased to 76 for June, from 73.6 in May.
Germany’s Ifo institute in Munich said last week its business climate index, based on a survey of 7,000 executives, increased to 101.8 from 101.5 in May. That’s the highest since May 2008. Economists expected a decline to 101.2, according to the median of 38 forecasts in a Bloomberg survey.
Japan’s Cabinet Office said June 10 the nation’s gross domestic product rose at an annualized 5 percent rate in the three months ended March 31, the biggest gain since the second quarter of 2009. The median of 18 estimates in a Bloomberg survey of economists was for a 4.2 percent pace.
Such data help explain why demand for Treasuries has diminished in the repurchase agreement market.
That’s a switch from recent years when the debt was in such high demand as credit markets froze that investors routinely lent cash for next to nothing just to obtain the securities through so-called repos, which securities firms use to finance their holdings.
“There are very few specials out in the market and that’s been the case for quite a while now,” said Thomas Simons, a money-market economist in New York at Jefferies & Co., one of the 18 primary dealers that trade with the Fed. “Around month-end, quarter-end, and definitely year-end, they tend to heat up in the last few days but it’s not like it used to be.”
The overnight repo rate on the current two-year Treasury, the 0.625 percent coupon security, closed the same as the general-collateral rate of 0.25 percent on June 25, according to GovPX. A year earlier, the overnight rate was negative 0.05 percent, while the general-collateral rate was 0.05 percent.
German bonds gained 6.69 percent this year, poised for the best first-half performance since 1995, according to Bank of America Merrill Lynch indexes. The gains pushed the yield on the 10-year bund to 2.5 percent on June 8, the lowest since at least January 1989, according to Bloomberg generic prices.
“We could see some calm return to the markets in coming months,” said Michiel de Bruin, who helps manage about $32 billion as head of European government bonds at the Dutch unit of F&C Asset Management in Amsterdam. “I can’t really see Treasury or bund yields falling much from current levels.”
Ten-year bund yields are forecast to rise from 2.61 percent from 3.11 percent by the end of the year, according to the median estimate in a Bloomberg survey.
In the U.K., where bonds have returned 5.62 percent since December, 10-year yields will likely rise to 4.05 percent in six months from 3.38 percent last week, a separate poll shows.
Japan’s government bonds have handed investors a 1.5 percent return this year. Ten-year yields, which touched 1.16 percent on June 23, the lowest since Dec. 30, 2008, will climb to 1.39 percent from 1.15 percent, another survey shows.
Not even a pledge by new Japanese Prime Minister Naoto Kan to restrict borrowing and overhaul the tax system will keep yields from rising, according to Shinji Nomura, chief debt strategist in Tokyo at Nikko Cordial Securities Inc., a unit of Japan’s third-largest banking group.
“Yields are too low to entice investors any longer,” he said. “The economy continues to recover after hitting bottom.”
For many investors, riskier assets are just too attractive to ignore after lagging behind bonds, regardless of what the economy does, according to Richard Schlanger, who helps invest $18 billion in fixed-income securities as vice president at Pioneer Investments in Boston.
“I would not want to be a buyer, a long term investor, of 10-year Treasuries at 3.09,” said Schlanger, a money manager at the firm. “It’s just hard to believe we can continue to rally in the Treasury market. Equities and commodities would be better places to put your money.”
Schlanger forecasts 10-year Treasury yields may reach 3.5 percent this year as the economy improves.