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Treasury Yields Only Turn Attractive at 3.5%, JPMorgan Says

U.S., German and U.K. government-bond yields are too low to be attractive given the outlook for improving global growth, according to JPMorgan Asset Management.

Treasury 10-year notes should yield 3.50 percent based on growth and inflation forecasts and the impact of the Federal Reserve’s asset purchases, instead of today’s 2.78 percent, JPMorgan executives said in a presentation in London. Yields on German bunds and U.K. gilts also should be higher, they said. T. Rowe Price sees U.S. 10-year yields rising more slowly than some investors expected, officials said at a separate event.

“We still can’t get too excited about government bonds,” said Iain Stealey, a portfolio manager for JPMorgan’s international fixed-income group. “If gilt yields or Treasury yields wax and wane, you can still lose a little bit of money owning government bonds. We don’t see there to be much opportunity there.”

The benchmark Treasury yield climbed to this year’s high of 3.01 percent on Sept. 6, from as low as 1.61 percent in May, as signs that the world’s largest economy is gaining momentum fueled bets the Fed is moving toward reducing its $85 billion a month in asset purchases. The yield was last at 3.50 percent in April 2011.

Treasuries have lost investors 2.5 percent this year after returning 2 percent in 2012 and gaining 10 percent in 2011, according to Bloomberg World Bond Indexes. Gilts dropped 3.6 percent and German securities fell 1.2 percent in 2013.

‘Low’ Yields

“People want fixed income that can potentially give them some sort of return, and government bonds used to do that,” said Nick Gartside, international chief investment officer for fixed-income at New York-based JPMorgan, which manages $1.5 trillion. “What we’re seeing from institutional investors is they want a source of fixed income that can potentially give them a return, which clearly with low government-bond yields and low corporate-bond yields is a stretch.”

German 10-year bund yields should be at 2.20 percent, versus 1.73 percent today, while similar-maturity U.K. gilts should yield 3.30 percent instead of 2.82 percent, JPMorgan executives said.

The company bases its estimate for where the Treasury 10-year yield should be on a 2014 growth forecast of 2.6 percent and inflation prediction of 1.9 percent, and a reduction of 1 percentage point due to the impact of the Fed’s debt-purchase program known as quantitative easing.

Gradual Transition

While bond yields will rise in scenarios where the economy continues to grow, “the transition from this 30-year bull market will be more gradual than some people had initially feared with the tapering comments we saw earlier” from the Fed, Michael Gitlin, head of fixed income at T. Rowe Price Associates Inc., said today at a media presentation in New York.

T. Rowe Price forecasts that the 10-year yield will rise to 3.25 percent by the end of 2014 as the economy recovers at a pace that is likely to be “average at best,” Gitlin said.

The Fed will probably reduce its purchases in the next few months even if the pace of economic growth is somewhat slower than most investors expect, the Baltimore-based executive said.

While benchmark yields will probably increase next year, “there are some opportunities out there,” Gitlin said.

Emerging-market corporate bonds, which have fallen less than sovereign debt this year, offer opportunities next year, particularly lower-rated securities, he said. In the U.S., high-yield debt and bank loans offer the opportunity for positive returns, he said.

“The market is still rewarding the lowest credit-quality credits in this environment,” Gitlin said.

‘Good’ Rotation

Even as about $130 billion left fixed-income funds and exchange-traded funds since May, only $60 billion of that went into equity portfolios, with $70 billion heading for money-market accounts, Gitlin said. That makes the rotation out of bonds and into stocks “a mildly good one” that will continue at a muted pace in 2014, he said.

That contrasts with the “Great Rotation” of assets away from safe holdings such as Treasuries and into riskier securities forecast by many strategists earlier this year.

Demand for longer-maturity securities will come from insurance companies and pension funds as they move to narrow the gap between their liabilities and their assets, while individuals will continue to put some money in bonds, he said.

“After two generational bear markets in equities in one decade, folks are more in tune with having balanced portfolios,” Gitlin said.

T. Rowe Price managed $647.2 billion as of Sept. 30.

“The fear of rates going a lot higher is misplaced,” Gitlin said. “The economy is going to be average; good enough for rates to go up a little bit, but not much.”

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