For Wall Street Bond Strategists, There’s Wrong and Less Wrong

  • Treasuries’ surge to record-low yields confounds forecasters
  • From Goldman to BofA, almost no one saw this rally coming

If at first you don’t succeed, revise, revise again.

That’s become the mantra of Wall Street’s bond-market forecasters this year. Stephen Stanley knows how frustrating it’s been. The chief economist at Amherst Pierpont Securities LLC has cut his Treasury 10-year yield forecast five times, to 2.2 percent from 3.6 percent.

“I’ve pretty much pulled out what’s left of my hair trying to figure out bond yields this year,” Stanley said.

He’s far from alone. Strategists who had watched the U.S. unemployment rate fall by half since the financial crisis entered 2016 fixated on domestic economic data and forecasting Treasury yields would rise. If inflation climbed toward the Federal Reserve’s 2 percent target, they saw the central bank having reason to raise interest rates as many as four times this year, in line with officials’ guidance at the time.

Instead, strategists have realized they missed the bigger picture. Yields tumbled amid a torrent of global economic and geopolitical surprises that prompted the Fed to cut its rate projections twice. That’s driven banks such as Deutsche Bank AG, JPMorgan Chase & Co. and Nomura Holdings Inc. to revise their forecasts repeatedly -- barely halfway through the year.

“Not only is the global environment directly impinging on the way the market has behaved, but it also seems to have taken on a bigger significance for the Fed,” Stanley said. “The Fed is being much more patient than I thought they’d be.”

Global Forces

The 10-year Treasury note yielded 2.27 percent on Dec. 31. That month, the median analyst forecast saw it rising to 2.78 percent by the end of 2016. 

The note yielded 1.49 percent as of 12:50 p.m. in New York on Tuesday, according to Bloomberg Bond Trader data, after posting a record-low close of 1.36 percent on July 8. The median forecast among 74 economists surveyed by Bloomberg now calls for yields to reach 2.10 percent by year-end.

For bond bears in 2016, everything has gone wrong. Equity markets faltered early this year as commodities tumbled on concern that a Chinese economic slowdown would curb global growth. Central banks in Europe and Japan adopted negative rates and expanded bond-buying programs as they struggled to stimulate inflation. Britain’s vote to leave the European Union fueled a clamor for haven assets that pushed global sovereign-debt yields to record lows. That’s boosted the comparative appeal of Treasuries, while making it harder for the Fed to tighten policy despite encouraging U.S. economic data.

Fixing Forecasts

Forecasters’ calls for yields at mid-year are off in 2016 by the most in any year in data compiled by Bloomberg going back to 2010.

By July 8, at least seven Wall Street firms had revised their year-end 10-year yield forecasts by three or more times this year, according to data compiled by Bloomberg. JPMorgan lowered its to 1.7 percent from 2.75 percent and Credit Suisse cut its to 1.4 percent from 2.95 percent, both in four separate revisions. Economists at BMO Capital Markets also cut their forecast four times, to 2.07 percent from 2.72 percent. Wells Fargo & Co. lowered its call to 2.03 percent from 2.60 percent in four moves.

Alex Roever, head of U.S. rates strategy in New York at JPMorgan Securities, said global monetary policy played heavily into his team’s revisions.

‘Feedback Cycle’

“Decisions by foreign central banks had a greater influence on longer-dated Treasuries than we expected,” Roever said. “Of all the factors we discussed in forecasting this year, we barely discussed what’s going on in the domestic economy. Three or four years ago, we paid attention to what was going on internationally, but it was very much more a domestic-focused conversation.”

BNP Paribas SA, in perhaps the most dramatic single revision this year, lowered its forecast in February to 1.50 percent from 2.75 percent, and also cut its prediction for Fed rate hikes in 2016 and 2017 to zero from seven. It now forecasts a 1.60 percent yield at year-end.

“There was such a strong feedback cycle between global financial conditions and U.S. interest rates,” said Timothy High, director of U.S. rates strategy at BNP Paribas in New York. “The thought process for us was that that was going to continue for the first half of the year, and then data was going to weaken for the second half.”

Fed Projections

Traders assign about a 35 percent probability to a Fed rate boost by year-end, according to futures data compiled by Bloomberg, down from a 93 percent chance seen as of the end of 2015. After lowering their projections in June, Fed officials expect one hike in 2016.

Not everyone has been wrong this year. Steven Major, global head of fixed-income research at HSBC, in January called for the U.S. 10-year yield to fall to 1.5 percent by year-end. He hasn’t changed his forecast.

While Treasury yields by year-end may still climb back toward where strategists saw them in January, they may fall further in the second half of 2016 if global geopolitical hits keep coming.

“If, for example, France or Italy were to vote to leave the European Union, or even the concerns around the Italian banking system, it could push the 10-year closer through the one” percent level, said George Goncalves, head of U.S. interest-rates research at Nomura Securities. “In order to broach these levels, completely disconnecting from fundamentals, we would need to see another crisis unfold, not just this chasing of yield and people covering shorts.”

Goncalves forecasts the 10-year yield will finish 2016 at 1.75 percent, having lowered that call three times from 2.5 percent at the start of the year.

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