Bloodied, Not Broken: U.S. Bond Market's Biggest Bears Die Hard

  • Best start for Treasuries since 2008 can’t last, says Loomis
  • 10-year yields at 1.8% “hard to get excited about,” Wamco says

The biggest bears in the U.S. bond market are standing their ground.

Despite the best start to a year for Treasuries since the credit crisis, Western Asset Management, Loomis Sayles and Franklin Templeton Investments say U.S. government bonds are a losing bet. The firms, which oversee more than $800 billion, contend investors are being driven by irrational fears about China, the commodities collapse and a weakening U.S. economy -- and making the mistake of pouring into Treasuries that yield less than 2 percent.

Treasuries are “very expensive,” said Carl Eichstaedt, who manages the $15.4 billion Western Asset Core Plus Bond Fund and favors investment-grade company debt and emerging markets. “If you are a Treasury bond bull today, you really have to have a negative picture on the global economy. The U.S is the bright spot. The worst of Europe is behind them and the world is too negative on China’s prospects.”

Yet as more investors abandon all but the safest assets, that view is proving harder to maintain. In the past month, Bank of America Corp., JPMorgan Chase & Co., Deutsche Bank AG, and most recently Goldman Sachs Group Inc. have cut their 2016 yield forecasts for Treasuries. Traders have also started to lose confidence the U.S. economy is strong enough for the Federal Reserve to raise interest rates this year.

Treasuries returned 2.7 percent in 2016 as of Friday, outpacing emerging-market sovereign debt and investment-grade company debt. Risk assets such as junk bonds have dropped 2.1 percent while equities globally have tumbled 8.2 percent.

Eichstaedt’s fund, which outperformed almost all his rivals last year, is languishing toward the rear of the pack, data compiled by Bloomberg show. Loomis Sayles’s $15.7 billion bond fund, which is “underweight” Treasuries, has lost 3.3 percent in 2016, making it among the worst in its fund universe. The $4.5 billion Franklin Total Return Fund has also been a laggard, beating only 43 percent of its peers.

Different Now

For years, investors and analysts alike have repeatedly gotten it wrong in calling for a resurgent U.S. economy to spur more inflation and higher bond yields. Loomis Sayles’s Matt Eagan says this time is different.

On Friday, the latest figures showed the U.S. jobless rate fell below 5 percent for the first time since early 2008, while wage growth held near a five-year high -- some of the strongest signs yet that the labor market can support more consumer spending. That’s bound to push up inflation, which has started to rebound after plunging with oil prices, and erode the value of the fixed-rate payments on Treasuries.

Core inflation, which strips out food and energy costs, is already running at 2.1 percent. That’s more than the Fed’s own inflation goal of 2 percent.

The benchmark 10-year note yielded 1.74 percent at 2 p.m. in New York.

Not Compensated

“To be long U.S. Treasuries now, one really has to be tied to a deflationary story,” said Eagan, a money manager at Loomis Sayles, which oversees $229 billion. “At the end of the day, my opinion is that reflation wins out. When you look at Treasuries, you have to ask yourself, am I getting compensated for taking the risk? The answer is no.”

While traders see the odds of a single rate increase this year at less than a coin flip, Mike Materasso, co-chair of Franklin Templeton’s fixed-income policy committee, predicts consumer-led growth will prompt the Fed to raise three times.

“We don’t think Treasuries offer great value fundamentally,” he said. “The labor market is doing well, which feeds into the consumer, which is the basis for our constructive view” on the economy.

Bank of America’s Ruslan Bikbov is less optimistic. While the gap between short- and long-term Treasury yields, known as the yield curve, indicates the economy isn’t at risk of falling into a recession, Bikbov says the Fed’s near-zero rate policy has kept the short end artificially low.

By using overnight index swaps to strip out the distortions, the bank’s U.S. rates strategist now says the curve would actually be inverted. Since the 1950s, the U.S. economy has contracted every time that’s happened.

Signs the economy may be faltering are emerging in other parts of the bond market. The extra yield investors demand to own the riskiest corporate bonds instead of Treasuries is now close to the highest since 2009, while the number of U.S. companies with the highest risk of defaulting is approaching a peak not seen since the height of the financial crisis.

The dim outlook has convinced some bond bears to rethink their assumptions. Jeffrey Rosenberg, the chief investment strategist for fixed income at BlackRock Inc., says his forecast for 10-year yields to reach 2.8 percent by year-end may be too high. BlueBay Asset Management’s Mark Dowding, who foresaw yields on Treasuries across all maturities rising at the start of the year, now says longer-term yields will drop.

Just don’t expect Western Asset’s Eichstaedt to be a buyer.

“Treasuries are a very expensive checking account,” he said. The 10-year note at “1.8 percent is hard to get excited about.”

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