Treasuries Surge With Global Bonds as Brexit Seen Sidelining Fed

  • ‘The Fed is on indefinite hold,’ Eagle Asset’s Camp says
  • U.S. 10-year note yield closes at lowest level since 2012

Treasuries surged, pushing benchmark yields down the most in almost five years, as Britain’s surprise vote to leave the European Union drove a rush for the safest assets.

Yields plunged across maturities as demand soared for U.S. debt, traditionally a haven for global investors during periods of stress. Derivatives traders don’t see the Federal Reserve raising interest rates for at least two years, with the market-implied probability of a rate cut this year climbing to 11 percent.

Britain’s decision to quit the EU after more than four decades shocked financial markets that had priced in a vote to remain in the 28-nation bloc even after polls showed the referendum was too close to call. The bond-market rally boosted the 2016 return on the Bloomberg U.S. Treasury Bond Index to 4.7 percent.

"The Fed is on indefinite hold -- it’s an infinite extension,” said James Camp, director of fixed-income with Eagle Asset Management, which manages about $30 billion in St. Petersburg, Florida. “We will see Treasuries continue to stampede to 1.25 percent, maybe 1 percent. It may happen over the next quarter. We’ve got a massively dislocating moment, and what are central bankers going to do, and do they have any bullets left?"

Yields Plunge

U.S. 10-year note yields fell 19 basis points, or 0.19 percentage point, to 1.56 percent as of 5 p.m. in New York, according to Bloomberg Bond Trader data, the lowest closing level since September 2012. The price of the 1.625 percent security due in May 2026 rose 1 22/32, or $16.88 per $1,000 face amount, to 100 19/32. The yield fell as low as 1.4 percent, approaching the record low of 1.38 percent reached in July 2012. The last time it fell more was in October 2011.

"Yields will continue to grind lower,” said Gary Pollack, who manages $12 billion as head of fixed-income trading at Deutsche Bank AG’s Private Wealth Management unit in New York. “The yield on the 10-year can get to 1.25 percent over the course of the summer. It’s a reflection of the global slowdown in the economy as well as investors looking for safety and security."

Two-year Treasury notes, the coupon maturity most sensitive to Fed policy expectations, pared gains after yields plunged as much as 0.28 percentage points. At 0.63 percent, the note’s yield closed at the lowest level since October, two months before the Fed raised rates for the first time in nearly a decade.

‘800-Pound Gorilla’

“The 800-pound gorilla in the room is, what is the Fed going to do?” said Mike Franzese, the New York-based head of fixed income at MCAP LLC, a broker-dealer. “Is it going to change this from a tightening bias of the Fed back to neutral? Back to cutting?”

A Bloomberg index of prevailing liquidity conditions in the Treasury market shows it worsened in the early morning hours in New York, then reverted to normal levels.

Japan’s 10-year bond yield slid to an unprecedented minus 0.215 percent, while 10-year yields in Germany and Britain fell to all-time lows.

Stress Gauge

“Why do you see the flight to quality? It’s because of the threat that these external shocks have had,” Jeffrey Rosenberg, New York-based chief investment strategist for fixed income at BlackRock Inc., said in an interview on Bloomberg Radio. “A small change can be a big turning point for the outlook -- not just for the U.K. or Europe, but for the global economy.”

Rosenberg said market volatility should settle down, and that the Brexit shock isn’t like the fallout seen during the 2008 financial crisis.

Bond manager Bill Gross said returns in the Brexit referendum are putting free-trade and immigration policies at risk, and will probably end chances of a Fed hike this year, and perhaps through 2017.

“Obviously, safe-haven bonds instead of equities will benefit,” Gross, manager of the $1.4 billion Janus Global Unconstrained Bond Fund, wrote in an e-mail.

A gauge of where bank borrowing costs will be in the months ahead, known as the FRA/OIS spread, rose to the most extreme level since 2012 as the referendum sapped investor appetite for risk and spurred concern some European banks will find it harder to fund themselves. 

The Fed said Friday it was carefully monitoring developments in global financial markets in cooperation with other central banks, and was prepared to provide dollar liquidity through its existing swap lines with central banks, as necessary, to address pressures in global funding markets, which could have adverse implications for the U.S. economy.

The Fed has standing arrangements for dollar liquidity swap lines with the Bank of Canada, the Bank of England, the European Central Bank, the Bank of Japan, and the Swiss National Bank.

“Central bankers are going to pour liquidity on these markets like a fire hose,” said Jonathan Lewis, who manages about $10 billion as chief investment officer in the U.S. for Fiera Capital Inc. “All Fed tightening is coming out of the Treasuries market, and that is really significant.”

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