Bonds’ Point of No Return About a Standard Deviation AwayAnchalee Worrachate and Cordell Eddings
The biggest monthly loss in fixed-income securities since 2004 has still left global yields short of the tipping point that would signal a bear market in bonds.
Yields on U.S. Treasuries, German bunds and Japanese government bonds are about one standard deviation above their historical norm. Treasury 10-year rates have reached two standard deviations above the average twice since 2009, and each time the notes rallied. While sovereign yields at 1.39 percent are above the record low of 1.14 percent set May 2, they are about half the 3.64 percent average of the past 20 years, based on Bank of America Merrill Lynch’s Global Government Index.
Bonds lost 1.5 percent in May after Federal Reserve policy makers sent mixed signals about whether they would slow the pace of their $85 billion a month in debt purchases this year. Tame inflation and lower global growth estimates from the International Monetary Fund indicate the world’s central banks won’t pull back anytime soon, averting a further rout.
“You’d need much more than these sort of yield increases to hang your hat on to say this is a start of a bond bear market,” Robin Marshall, a director of fixed income at Smith & Williamson Investment Management in London, which oversees about $21 billion, said in a May 30 phone interview. “I’ve seen one in the early 1980s, and this doesn’t look like it. Inflation is still very low, and we need to see more convincing evidence of the economy strengthening, not just in the U.S. but elsewhere.”
While Bill Gross, who runs the world’s biggest bond fund for Pacific Investment Management Co., said May 16 that fixed income’s three-decade bull market “was over,” trading patterns suggest the increase in government debt yields isn’t abnormal. Gross said on May 31 that Newport Beach, California-based Pimco likes Treasuries that mature in 5-to-10 years as there will be “no tapering for now.”
Yields on 10-year Treasuries rose 46 basis points in May, including a jump of 16 basis points, or 0.16 percentage point, on May 28, as a report showing consumer confidence climbed to the highest in more than five years bolstered speculation the Fed would scale back its purchases.
The 10-year Treasury rate rose three basis points to 2.16 percent at 6 a.m. New York time today. Similar-maturity German bund yields increased four basis points to 1.54 percent.
The rate on the German securities climbed 29 basis points last month, the biggest increase since January, while those for Japanese bonds rose 26 basis points to 0.86 percent, after reaching 1 percent on May 23, the highest since April 2012.
Yields on Treasuries and bunds are more than 40 basis points below what would be two standard deviations from their means, according to data compiled by Bloomberg. Japanese bonds are about five basis points away.
Standard deviations measure how tightly a data series is moving relative to the average. A price that’s two standard deviations away from its long-term level is considered “extreme and excessive” and may suggest a market is about to turn from its trend, according to Tom Fitzpatrick, the chief technical analyst at Citigroup Inc. in New York.
Standard deviations greater than one occur about 32 percent of the time in statistical models. The chance of yields reaching two standard deviations is about 5 percent over any given time, and below 0.3 percent for three levels.
“It may not be a chart holy grail, but it’s a pretty good warning sign,” Fitzpatrick said in a phone interview on May 31. “Yields have been going down in the past 32 years. Although they can’t keep falling forever, all indicators we look at currently suggest we are not at that turning point yet.” Treasury yields will probably set fresh 2013 lows in the second half of the year, he said.
Chairman Ben S. Bernanke said May 22 that the Fed was seeking “real and sustainable” progress in shrinking unemployment before it would reduce monthly bond purchases. With joblessness of 7.5 percent still higher than before the last recession, the Federal Open Market Committee announced May 1 that it would increase or decrease the pace of buying in response to changes in inflation and the labor market.
The policy makers maintained monthly buying of $40 billion of mortgage securities and $45 billion of Treasuries in a bid to boost employment. The purchases have expanded total Fed assets to a record $3.4 trillion from less than $1 trillion in 2008.
“Investors are wary of stepping in front of what has historically been a freight train when the Fed acts or is perceived to be getting ready to act,” said Robert Tipp, chief investment strategist in Newark, New Jersey, for Prudential Financial Inc.’s fixed-income division, which oversees $335 billion. “But most of the selloff is probably behind us at this point,” he said by phone on May 29.
That view isn’t shared by Zach Pandl, a senior interest-rate strategist in Minneapolis at Columbia Management Investment Advisers, which oversees $340 billion. He sees yields starting to rise because their historically low levels won’t last when growth picks up.
“We are entering into a period of sustained increases in rates,” Pandl said in an interview on May 28. “The Treasury market has had a fantastic run, and that has probably come to an end. We’ve passed that inflection point as evidenced by the improvement in housing and the labor market. We’ve seen enough evidence of a self-sustaining recovery.”
Led by the Fed’s bond purchases, central banks from the Bank of Japan to the Bank of England have flooded the world with trillions of dollars of cash.
Even so, concern that inflation will accelerate has been supplanted by the prospect of disinflation, or a slowdown in the pace of price increases, as major economies outside the U.S. struggle to expand and commodities decline.
Global inflation expectations, as measured by the gap in yields between index-linked and nominal government bonds, fell to 1.44 percentage points on May 31, the lowest in nine months, from a two-year high of 1.73 percentage points in April, according to data compiled by Bank of America Merrill Lynch.
The IMF on April 16 trimmed its forecast for global growth this year to 3.3 percent from 3.5 percent even as the U.S. shows signs of recovery. China’s Premier Li Keqiang told German business leaders on May 27 that his country is confronted by “huge challenges” after the nation expanded 7.8 percent in 2012, the slowest pace in 13 years.
“The U.S. is not an island in the world economy,” said Prudential’s Tipp. “Most of the data coming in from major trading partners is disappointingly slow.”
While Bernanke said last month the Fed “could” start to pare back on bond buying if it was confident of a sustained recovery, other central banks have loosened monetary policy, which has kept yields under pressure.
Haruhiko Kuroda, governor of the BOJ, is pursuing unprecedented stimulus to jolt Japan out of deflation. The European Central Bank cut its benchmark rate by 0.25 percentage point to a record 0.5 percent on May 2, and speculation has mounted that the Bank of England will increase its bond-buying target after Mark Carney takes over as governor next month.
The economy of the 17-nation euro area will shrink 0.6 percent this year after contracting 0.5 percent last year, the Organization for Economic Cooperation and Development said on May 29. The region’s unemployment rate climbed to a record 12.2 percent in April as its recession deepened, the European Union statistics office in Luxembourg said on May 31.
“The euro zone economy has been struggling and it needs more stimulus from monetary policy,” Kazuyuki Takigawa, who oversees $6 billion of non-yen bonds at Resona Bank Ltd. in Tokyo, said in a phone interview on May 29. “Current policy is restrictive. The economy needs another rate cut, maybe 25 basis points within a couple of months.”
Rising bond demand from retirees seeking regular income will help to cap yields, Rick Rieder, chief investment officer for fundamental fixed-income at BlackRock Inc., said in a phone interview on May 29. The New York-based company is the world’s largest money manager, with $3.94 trillion of assets.
That’s coinciding with a shrinking supply of high-quality bonds. The number of securities rated AAA or AA in indexes compiled by Bank of America Merrill Lynch dropped to 6,168 on May 31 from 7,728 five years ago.
“There is too much demand for fixed income and for yield and there isn’t enough supply in a deleveraging world,” Rieder said. “The population is aging and true income levels haven’t grown much. The pressure for rates to stay low is just too great. It’s so intense that every time rates move up, people will enter to take advantage of better yields.”
Central banks may also consider last month’s bond market selloff as they adjust their monetary policy, because of the effect of higher yields on government financing costs, as well as rates for mortgages and credit cards.
“The market might be getting a bit ahead of itself,” Willem Sels, the London-based head of global investment strategy at HSBC Private Bank, which manages $480 billion, said in an interview on May 29. “While the economy in the U.S. is improving, other major economies are still weak. It’s possible we’ve seen the low in yields in this cycle, but I don’t think central banks will be happy to see bond yields rising much higher from here.”