Treasuries Are a Winner as China Exports Deflation Says Bill Gross

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Treasuries have a lot of things going for them.

Bill Gross says a weakening Chinese yuan will bring slower inflation worldwide. Investors are reducing bets for the Federal Reserve to raise interest rates at its September meeting as China struggles to spur growth in the world’s second-largest economy. And the nation’s move to devalue its currency is also fueling demand for dollar-denominated assets.

“The weak Chinese economy seems to require a competitive devaluation against other Asian producers which points to weak global growth, lower commodity prices and again, lower inflation worldwide,” according to Gross. “The disinflationary-deflationary effect will keep 10- and 30-year Treasuries well-bid.”

Gross, a portfolio investor with Denver-based Janus Capital Group Inc. and the former manager of the Pimco Total Return Fund, made his comments in an e-mail Tuesday.

Treasuries rallied for a second day as the People’s Bank of China devalued the yuan on Tuesday to boost demand for its exports. Benchmark 10-year yields dropped to as low as 2.04 percent, the least since April 30, while the 30-year bond yield touched 2.72 percent.

‘Big Shift’

Traders were on guard at National Australia Bank Ltd. in Sydney, according to Head of Research Peter Jolly.

“This is a big shift” in Chinese policy, he said. “The chats were very active and people keenly awaited the fixing,” when China sets its currency rate target.

The benchmark U.S. 10-year note yield fell four basis points, or 0.04 percentage point, to 2.1 percent as of 8:10 a.m. New York time, according to Bloomberg Bond Trader data. The 2.125 percent security due in May 2025 rose 11/32, or $3.44 per $1,000 face amount, to 100 6/32. The yield dropped nine basis points on Tuesday, the steepest decline since July 6.

China’s “yuan devaluation exports their deflation to other countries,” Gross wrote in a tweet Tuesday. “Bullish for bonds. Bearish for stocks.”

The difference between yields on U.S. 10-year notes and similar-maturity Treasury Inflation Protected Securities, a gauge of trader expectations for consumer prices over the life of the debt, dropped to as little as 1.62 percentage points, the least since March 17. The average for the past decade is 2.14.

A falling inflation rate is positive for bonds because it enhances the value of their fixed payments.

Debt Sale

The impact on demand will be gauged at a $24 billion auction of notes due in August 2025 on Wednesday that could see borrowing costs drop to the lowest since April. The Treasury last sold 10-year debt on July 8 at a yield of 2.225 percent. The securities due to be sold Wednesday yielded 2.11 percent in pre-auction trading.

Fed policy makers have kept their main rate, the target for overnight loans between banks, in a range of zero to 0.25 percent since 2008 to support the world’s biggest economy.

There’s a 42 percent chance the central bank will boost its benchmark at its Sept. 16-17 meeting, based on the assumption that the benchmark will average 0.375 percent following the increase, data compiled by Bloomberg show. The odds are down from 54 percent on Aug. 7.

With 30-year Treasury yields touching the lowest since April 29, investors may be over discounting the chances of a rate increase, according to John Bilton, JPMorgan Asset Management’s head of global strategy.

“Term risk premia now, in the long end of the U.S., are extremely compressed and that concerns me,” Bilton said in an interview on Bloomberg Television’s “On the Move” with Jonathan Ferro. “We could be ahead of a Fed rate hike, entering a time when we need to rethink those duration longs.”

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