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U.S. Yields Near 2% Make Traders Wonder Where Animal Spirits Are

  • America's economic potential is waning, Sumitomo Mitsui says
  • Low yields don't automatically mean recession, BNP says

Treasury benchmark yields that fell to 2 percent this month are raising concern the U.S. economy is losing momentum.

Yields tumbled as a 8 percent decline in the Standard & Poor’s 500 Index in January, crude oil at a 12-year low and falling inflation expectations sent money managers to the haven of government securities. While the U.S. is adding jobs, manufacturing is contracting. Investors are trimming forecasts for how much the Federal Reserve can raise interest rates.

“The American economy has lost its animal spirits,” said Hideaki Kuriki, a bond investor in Tokyo at Sumitomo Mitsui Trust Asset Management, which oversees $55 billion. “The potential growth rate of the American economy is going down. Longer term, yields may go down.”

Treasuries dropped for the first time in five days on Tuesday with the 10-year note yield climbing three basis points to 2.07 percent as of 2:28 p.m. in Tokyo, according to Bloomberg Bond Trader data. The price of the 2.25 percent security due in November 2025 fell 9/32, or $2.81 per $1,000 face amount, to 101 5/8.

Analysts Thwarted

The yield declined to a three-month low of 1.98 percent last week, thwarting analysts who projected the benchmark would rise after the Fed increased rates in December. Treasuries resumed trading in Asia Tuesday after being closed worldwide Monday for a U.S. holiday.

Demand for the benchmark 10-year notes shrank their extra yield over two-year securities to as little as 114 basis points last week. The last time the spread was so narrow was during the last recession in 2008.

Economist John Maynard Keynes used the term “animal spirits" in the 1930s to describe the importance of consumer confidence in driving business activity. The Japanese experience shows it’s not easy to evoke them, as economic growth and bond yields both hover near zero. Sumitomo Mitsui Trust’s Kuriki said Treasury yields may be less than 2 percent for the next three-to-five years.

The difference between yields on 10-year notes and similar-maturity Treasury Inflation Protected Securities, a gauge of expectations for consumer prices over the life of the debt, was 1.39 percentage points. The spread shrank to 1.379 on Sept. 29, the narrowest since May 2009.

Fed Odds

The odds that the Fed will raise its benchmark at least once in 2016 have fallen to 69 percent from 93 percent at the start of the year, according to data compiled by Bloomberg based on futures contracts.

January’s flight to quality and tumble in yields won’t automatically translate into an economic slowdown, said Tomohisa Fujiki, head of interest-rate strategy for Japan for BNP Paribas SA in Tokyo. The company’s U.S. unit is one of the 22 primary dealers that trade directly with the Fed.

“This 2 percent itself does not instantly mean recession,” Fujiki said. “We are expecting a pickup in activity in the first quarter of 2016,” The yield will rise to 2.75 percent by Dec. 31, BNP predicts.

‘Basically OK’

Treasury yields probably fell too far given the pace of U.S. growth,  said Kazuaki Oh’E, head of fixed income at CIBC World Markets Japan Inc. in Tokyo. “I’d like to sell at this level,” he said. “The U.S. economy should be basically OK.”

Gross domestic product probably expanded 2.4 percent in 2015, and will maintain that pace in 2016, based on Bloomberg surveys of economists.

Mizuho Asset Management isn’t so optimistic.

“Recession is too strong” a word to describe the economy, said Yusuke Ito, a senior investor in Tokyo at the company, which oversees about $42.5 billion. “Stagnant is a better word. Growth is going to be sluggish for a long time.” He’s betting on long-term Treasuries, he said.