Bond Secrets Decoded 9,539 Miles From Wall Street in LotAnchalee Worrachate and Chanyaporn Chanjaroen
To understand where the global bond market is headed, follow the droves of housewives and elderly men who make their way to the parking lot of a public-housing block in Singapore’s Jurong area each weekday morning.
That’s where you’ll find Steven Chan Soon Fatt, who buys everything from old newspapers to scrap metal that he resells to local factories. While business is brisk for the fine copper wire that the men strip from discarded motors, the 58-year-old former taxi driver offers just S$6.20 ($4.75) a kilogram, or about 40 percent less than he did some three years ago.
“Prices came down so much,” Chan, who started dealing in scrap in March 2008 as the financial crisis worsened, said on a recent morning in November. “We have no choice but to follow the levels set at factory.”
Chan’s predicament is emblematic of the tumble in commodity prices worldwide, compounded by OPEC’s refusal last week to ease a glut of oil supply, which has held inflation in check and raised concern global economic growth is weakening. That in turn has helped fuel the biggest bond returns in a decade, a rally almost no one on Wall Street predicted at the start of the year.
Commodities have become so influential in shaping investor perceptions in the bond market that prices of copper, used in everything from property construction to high-voltage cables and mobile phones, have explained changes in the long-term outlook for U.S. inflation about 70 percent of the time in the past two years, data compiled by Bloomberg show.
Globally, bond investors anticipate consumer prices will rise an average 1.18 percent a year, based on yields of government debt for developed nations included in indexes compiled by Bank of America Corp.
Inflation expectations were almost twice as high in 2008, reaching a record 2.14 percent, the data show.
“It’s much too early to exit the fixed-income market,” Stefan Kreuzkamp, the Frankfurt-based chief investment officer for Europe, the Middle East and Africa at Deutsche Asset & Wealth Management, which oversees about $1.25 trillion, said by telephone on Nov. 25. “While we are not in the deflation camp, we’ve seen some slippage in inflation expectations.”
While falling costs of everything from gasoline to soybeans has lent credence to the notion that a pickup in consumer spending will lift economic growth, bond investors are counting on the slump in commodities to temper any erosion in the value of fixed-income payments caused by inflation.
Since its high in April, the Bloomberg Commodity Index of 22 metals, fuels and grains has dropped about 19 percent through last week and slumped to a 5 1/2-year low.
The benchmark copper price on the London Metal Exchange rose 1.6 percent to $6,454 a ton at 12:45 p.m. in New York, after falling as low as $6,230.75, the least on an intraday basis since 2010. It’s headed for the first successive annual declines since 2001. The metal has plummeted about 40 percent from its record in 2011 as China, which consumes more than two-fifths of world supply, heads for its weakest growth since 1990 and producers from Chile to Australia boost output.
The drop explains why factories that buy scrap metal are paying less to sellers like Chan, who has had to chop his own price for copper wire from more than S$10 a kilogram.
Goldman Sachs Group Inc. anticipates benchmark prices may have further to fall. On Nov. 17, the New York-based company cut its 2015 copper forecast by 3 percent to $6,217 a ton.
U.S. crude oil prices, which have dropped about $40 a barrel since June, plunged by the most since 2009 on Nov. 28 to end the week at $66.15 after the Organization of Petroleum Exporting Countries kept its production ceiling unchanged even as global demand fails to keep pace. The fuel fell as low as $63.72 today, a level last seen in July 2009.
The lack of price pressures in the developed world is already emerging as a greater threat. The inflation rate for the 18-nation euro area declined to 0.3 percent in the 12 months ended November, matching a five-year low.
In the U.S., the Federal Reserve’s preferred gauge has failed to increase more than its goal of 2 percent for 30 consecutive months. In both Europe and the U.S., inflation was closer to 3 percent just three years ago.
“Lower commodity prices have changed the investment landscape,” Jim Balfour, the senior global strategist at Loomis Sayles & Co., which manages $223 billion, said by telephone from Boston on Nov. 26. “They are raising deflation risks in the euro zone and will keep inflation in the U.S. stubbornly low.”
Copper itself has become one of the more accurate indicators of future growth and inflation for bond investors.
Price fluctuations of the metal have done a better job predicting economic growth in the following year than oil, gold or an index of commodities, according to K. Geert Rouwenhorst, a finance professor at Yale University’s School of Management.
Rouwenhorst, who is also a partner at SummerHaven Investment Management LLC, looked at correlations between commodity prices and economic growth from 1871 to 2011.
The bond market’s inflation expectations based on a metric known as the five-year, five-year forward break-even rate, has moved with copper prices seven times out of every 10 since November 2012, data compiled by Bloomberg show. In the prior decade, the two had little, if any, relationship.
The metric, which measures the five-year inflation outlook five years in the future, has fallen from 2.69 percent at the end of last year to 2.08 percent, the lowest since 2008.
That’s all added up to lower yields as investors poured into fixed-income securities. The 7.2 percent return in bonds worldwide is the most since 2002, index data compiled by Bank of America show. Average yields ended at 1.54 percent last week, or less than 0.1 percentage point from an all-time low.
The demand upended projections by strategists and economists for bonds to tumble this year, prompting all but one of the 84 surveyed by Bloomberg to reduce their year-end forecasts for 10-year Treasuries in the past 12 months.
They now anticipate yields will end the year at 2.5 percent, based on the median estimate, versus 3.44 percent in January. The yield was at 2.19 percent today, down from 3.03 percent at the end of 2013.
Lower inflation is “consistent with a low-for-longer theme for interest rates and yields,” Frances Hudson, an Edinburgh-based global thematic strategist at Standard Life Investments Ltd., which oversees $334 billion, said by telephone Nov. 24.
While the slump in commodities has helped to contain inflation, it may ultimately bolster economic growth and prices as consumers and businesses benefit from lower costs, said Michael Pond, the head of inflation-linked research at Barclays Plc, one of 22 primary dealers that trade with the Fed.
“The net effect of falling commodity prices on the U.S. is considerably positive,” he said by telephone from New York on Nov. 25. “It’s essentially a tax cut and will eventually bolster real consumer spending.”
Buoyed by more jobs and lower gasoline costs, the world’s largest economy grew faster last quarter than first estimated, capping its strongest six months in a decade, revised data from the Commerce Department showed last week.
Economists surveyed by Bloomberg estimate U.S. growth will reach 3 percent next year, the strongest since 2005, and help push up yields on the benchmark 10-year note by more than a full percentage point to 3.24 percent as the Fed moves to raise interest rates from close to zero.
Steven Major, the global head of fixed-income research at HSBC Holdings Plc and one of the few forecasters to foresee a drop in yields this year, is convinced borrowing costs globally will stay low as growth and inflation continue to disappoint.
In January, he said yields on the 10-year note would fall to 2.1 percent by year-end and hasn’t changed his call.
Since the recession ended in 2009, the U.S. economy has grown at an annual rate of 1.8 percent on average. In the prior three expansions, growth averaged more than 3 percent. Average hourly wages in the U.S. have remained flat or risen just 0.1 percent in five of the past eight months.
The decline in commodities “might give the beaten-up consumer a bit of relief but it’s not going to necessarily send him on a binge,” he said in an interview from London on Nov.
12. “Yields are likely to stay low.”
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