Treasury Traders Glimpse Rates Future Over Atlantic: U.K. Credit

U.S. bond traders seeking a glimpse of the future should look across the Atlantic.

That’s the view of New York-based investor Michael Shaoul, who says shorter-maturity Treasuries will come under the most pressure when the Federal Reserve moves closer to tightening policy. In Britain, two- and five-year gilt yields are rising relative to their U.S. peers amid expectations the Bank of England will be the first major central bank to begin exiting emergency stimulus.

“The U.K. bond market is much more important for U.S. investors than they probably realize,” Shaoul, chief executive officer of Marketfield Asset Management LLC, which oversees more than $20 billion, said in a June 30 phone interview. “It’s your best guess as to what the U.S. is going to look like further down the road.”

Traders are betting the BOE will raise the benchmark rate from a record-low 0.5 percent -- its level since 2009 -- by February after Governor Mark Carney said last month an increase could come earlier than markets expected.

The Fed may refrain until the second half of 2015, with Chair Janet Yellen saying rates are set to stay low for a “considerable time” after asset purchases end.

Pacific Investment Management Co. predicts an increase in about a year, while BlackRock Inc. says the Fed will move in the second quarter. Traders see just a 18 percent chance officials will raise the key rate from near zero by March, fed funds futures show.

Yield Spreads

Five-year gilt yields, which were below their U.S. counterparts as recently as September, were 43 basis points higher at 4:57 p.m. London time. The two-year spread reached 45 basis points, the widest since August 2011. Ten-year rates have remained within 16 basis points of each other this year.

“As the likelihood of a central bank finally raising interest rates comes into play, you don’t see a massive dislocation of the long end of the curve,” Shaoul said. “What you do see is the shorter and medium-term yields moving higher. That’s likely to be the story over here. I think we’re a couple of quarters behind the U.K.”

Marketfield, whose assets have grown from $400 million in 2010, has no “direct exposure” to U.K. yields, Shaoul said.

While Carney has convinced investors the BOE will raise rates before long, the precise timing is unclear. In testimony to a parliamentary panel last week, he tempered his comments on the possibility of an increase as early as this year, prompting opposition Labour Party lawmaker Pat McFadden to compare his behavior to that of an “unreliable boyfriend.”

Carney Impact

Even so, Carney has stressed that when borrowing costs do go up, increases will be limited and gradual, with rates settling well below the 5 percent average seen before the financial crisis. A rate of about 2.5 percent in three years, as projected in financial markets, is consistent with the economy returning to normal, he said last week.

Investors have reduced bets on the extent of future rate increases. One-year interest-rate swaps, currently about 0.93 percent, will reach 2.87 percent in five years, forward rates show. That’s down from about 3.4 percent at the end of 2013. Short-sterling futures maturing in December 2017 yield 2.94 percent. Contracts of a similar maturity yielded more than 4 percent in 2011.

“The Fed will most likely pursue the same route as Carney,” said Michael Markovich, head of quantitative analysis at Credit Suisse Group AG in Zurich. “Communicating lower for longer will be the dominant strategy for them. It’s the obvious choice.”

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