JPMorgan Unit Sees Unprecedented Bond Risks as Treasuries Slide

  • Debt trades on what others are willing to pay, Aronov says
  • Real yield on 10-year Treasuries is near the lowest in decades

Investors flocking to U.S. Treasuries in a world inundated with negative-yielding sovereign bonds should think again, according to J.P. Morgan Asset Management.

Here’s why: With much of the global bond market stripped of any yield, securities trade based on what someone else might pay for them in the future, a dangerous proposition, said Oksana Aronov, a managing director at JPMorgan Chase & Co.’s asset management division, which oversees $1.7 trillion. Central banks, including the Federal Reserve, are at the whim of market forces, she said.

And Treasuries, which investors have snapped up in 2016 as an alternative to sub-zero interest rates in Europe and Japan, aren’t as high-yielding and risk-free as some investors might believe. When factoring in inflation, the real yield on 10-year Treasuries is also negative, near the lowest since 1980 and even lower than the real yield on similar-maturity Japanese government debt.

“We’re seeing this tremendous flow into the bond space at a time when the risks are, frankly, unprecedented,” Aronov said Wednesday on Bloomberg Television. For investors buying Treasuries, “there is no free lunch, and on a real basis, you are really not buying something that’s of tremendous value.”

The benchmark U.S. 10-year note yield rose three basis points, or 0.03 percentage point, to 1.58 percent at 5 p.m. in New York, according to Bloomberg Bond Trader data. The 1.625 percent security due in May 2026 fell 1/4, or $2.50 per $1,000 face amount, to 100 13/32.

Ten-year bonds declined Wednesday in all but three of 25 developed-market countries, data compiled by Bloomberg show. 

U.S. yields are coming off their biggest weekly increase in a year as the American economy shows signs of strength. Citigroup Inc.’s U.S. Economic Surprise Index, which measures whether data beat or miss forecasts, has surged this month, rising to the highest since January 2015.

With the improved data, traders are boosting bets that the Fed will raise interest rates this year. Futures contracts indicate a 48 percent chance the central bank will lift its benchmark by the close of 2016, near the probability seen before the June 23 U.K. vote to leave the European Union.

Fed Options

Policy makers will likely say they’re keeping all options available, yet they probably won’t raise rates until the middle of next year, said Priya Misra, head of global interest-rates strategy in New York at TD Securities, one of the 23 primary dealers that trade with the Fed. She has one of the six lowest forecasts for 10-year Treasury yields at year-end among the 63 surveyed by Bloomberg, at 1.4 percent.

“People were getting nervous about the U.S. growth momentum -- that’s been taken away,” Misra said in an interview on Bloomberg Television. Still, Brexit “is a slow uncertainty shock, which I think over time is going to affect growth in the U.K. and EU. The Fed in the face of that will be nervous to hike.”

Even if the Fed focuses on the U.S. economy, the risk for bond investors is that policy makers have shown they’ll act differently on the same data depending on market reaction, Aronov said. The Federal Open Market Committee is scheduled to next meet July 26-27.

“The Fed is again starting to put the possibility of a September hike back on the table,” she said. “Should the market start to experience jitters, they’re going to back off of that.”

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