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The bond market, has proved to be an excellent predictor of shifts in the U.S. economy over the decades. Since 1960, they have predicted seven of the last eight recessions when 10-year yields fell below 3-month bill rates, according to data compiled by Bloomberg. And now it has an important message for the Fed. Interest rates aren’t going to rise as high as you think they are.
Traders say there is little chance the economy will strengthen enough over the course of its expansion to compel the Fed to lift its overnight rate beyond about 3.3 percent. That’s well below the historical average of 4.25 percent that New York Fed President William Dudley said would be consistent with the central bank’s current target for inflation.
The divergence reflects deepening concern among bond investors that tepid wage growth and a lack of inflation will persist for years to come, and hold back growth as the Fed moves to end its unprecedented monetary stimulus. Lower peak rates will also reduce the likelihood of any selloff in longer-term Treasuries, which have rewarded holders this year with the biggest returns in two decades.
“The market’s pricing in an extraordinarily slow Fed,” Margaret Kerins, the Chicago-based head of fixed-income strategy at Bank of Montreal, one of 22 primary dealers that trade with the central bank, told Bloomberg. “Potential growth is a huge determinant of that long-term rate and most people are buying into the idea of lower potential growth.”
“The market clearly doesn’t believe in the Fed’s forecasts,” Thomas Costerg, an economist at Standard Chartered Plc, said in a May 21 telephone interview from New York.
Even though the dots representing the views of individual Fed officials are anonymous, Chair Janet Yellen’s own concern over slack in the labor market suggests she may also see rates ending at a lower level than many of her colleagues and help to sway their assumptions for growth and rates, according to Michael Gapen, a senior U.S. economist at Barclays Plc.
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Todays Other Top Stories
Reuters: – Airports seeking lower interest rates lead U.S. muni bond sales next week. – Airport bonds lead the $4.3 billion of U.S. municipal bond sales next week, a slight slump as the market closes for the Memorial Day holiday on Monday, according to Thomson Reuters estimates.
Bloomberg: – Washington Airports Authority plans $542 million of bonds. – The agency that runs the two main Washington-area airports is planning to offer $542 million of bonds, in one of the week’s biggest muni debt sales.
Lenny Grover: – Looming public pension crisis is bigger than it appears. – Public pension plans are vastly underfunded and imperil state and local budgets over the long-term. High credit ratings and optimistic actuarial assumptions mask the full extent of the looming crises. Low yields on long-term municipal bonds reflect hunger for yield and obliviousness to underlying risks.
SacBee: – San Juan aims to pay off school bond debt more quickly. – School districts usually pay to fix up schools and build new ones by floating bonds and repaying them over a long period, often as much as 25 years. Now the San Juan District is considering repaying its debts much faster to save on interest costs.
Conk.com: – Puerto Rico municipal bonds commentary. – Puerto Rico has been in the news recently over its fiscal problems, under-funded pensions, and its rating agency downgrades that have taken the credit to the brink of junk. What is the outlook for Puerto Rico bonds in short term.
Reuters: – Speculative net shorts in U.S. 10-year T-note futures rise. – Speculators’ net bearish bets on U.S. 10-year Treasury note futures rose in the latest week, while speculative net shorts in Eurodollar futures held near their record level, according to Commodity Futures Trading Commission data released on Friday.
4Traders: – Treasury bonds slide on durable goods data. – U.S. Treasurys were off to a tepid start after the long weekend as an upbeat business spending release sapped demand for safe assets.
Investing.com: – Is the 2014 Treasury bond rally coming to an end? – One of the consensus themes for 2014 was the expectation that interest rates would continue to climb against the backdrop of an improving global economy. As you can see from the 10 Barron’s strategists forecasts for 2014, only one of the ten strategists saw the U.S. 10-Year yield remaining below 3%.
WSJ: – Favor Triple-B corporate bonds, Barclays says. – Bonds rated in the triple-B-category, the low end of investment grade, are poised to do better than some higher-rated bonds in the coming months, analysts from Barclays said in a research note Friday.
Market Realist: – Must-know: The corporate debt market. – Corporate debt (debt issued by corporations) can be classified in various ways. It can be classified in terms of maturity, the type, and the issuer’s credit quality.
Zero Hedge: – The impact of inflation and the Fed on indices and corporate bonds. – Everyone’s talking about the Federal Reserve’s exit strategy and whether rates will increase before or after it contracts its balance sheet. A major topic is inflation, and specifically the most recent increases in the Consumer Price Index (CPI) on a year over year basis.
Investing.com: – U.S. corporate bonds trade below pre-recession levels. – Top rated investment grade US corporate bonds now trade at or even below pre-recession levels. Depending on the maturity and the type of issuer, new issue paper clears the market at spreads (to treasuries) of 30-80bp for AAA bonds.
High Yield Bonds
Businessweek: – The bearish signs junk buyers reject in stoking ’14 rally. – This year’s unexpected bond boom may look like a rally, but it doesn’t smell like one. At least not to Morgan Stanley strategists, who detect something amiss in the way different securities are performing relative to one another.
Barrons: – Ignoring the reality of junk. – (Subscription Required) Just about everybody agrees that junk bonds look seriously overvalued. And just about everybody keeps buying them. Someday behavioral economists may look back at today’s high-yield bond market as a textbook study in how investors can continue to buy something even when they believe it’s significantly overpriced.
ElliottWave: – Why Europe’s junk bond boom is EVERYONE’S business. – You know junk bonds are risky. They’re often backed by companies with unproven results, untested growth, and often vague, sometimes unscrupulous businesses practices. To paraphrase the father of low-grade debt Michael “King of Junk” Milken.
Businessweek: – Leverage addicts get junk-loan fix with derivatives ETF. – Forget complicated total-return swaps and collateralized loan obligations. A proposed exchange-traded fund will make it much easier for anyone to use borrowed money to double down on junk-rated loans.
Emerging Markets Daily: – Emerging markets capital inflow dominated by ETFs. – For the week ending May 21, a total of $1 billion flowed into emerging markets dedicated equity markets, versus $0.46 billion for the last week. The capital inflow was dominated by the $1.05 billion GEM ETF funds, while non-ETF funds reported outflows for the fourth consecutive week, at $0.25 billion. Emerging Asia funds saw an outflow of $0.6 billion.
Investment News: – After a drop from the Federal Reserve’s tapering scare, fixed income assets have rebounded. – Emerging markets are rebounding as part of a significant turnaround that is setting them apart from other asset classes in fixed income, making them an attractive risk reward proposition for investors.
FT: – Investors jinxed by quirky market logic. – There are times when market behaviour appears to defy economic logic. That has certainly been the case in 2014, which has thrown up a number of investment puzzles, starting with the strength of government bonds in the developed world.
LearnBonds: – Why is a properly diversified fixed income portfolio so important today? – Conditions are developing which should favor lower-end investment grade and upper-tier high yield corporate bonds and BBB to AA-rated municipal bonds. On the equity side, go large, watch your P/E ratios and remember, dividends matter.
Journal Sentinel: – In challenging bond market, put focus on total return. – After a more than 30-year bull market in bonds, the landscape has changed. As interest rates plunged from their 1981 peak, bond prices rose, creating a spectacular run for fixed-income investors.
Pensions and Investments: – Managers not straying far from traditional fixed income. – Expectations that asset owners would be investing more in alternatives to fixed income didn’t come to fruition in 2013, according to Pensions & Investments’ 2013 money manager survey, as assets in traditional yield-seeking credit investments were the only ones to see gains last year.
CNBC: – Whatever happened to the great rotation? – The long-predicted “great rotation” out of bond investments appears to have fizzled, with funds headed back into fixed income, frustrating forecasts for higher yields.
About.com: – Bonds aren’t as safe as they used to be, but they still provide stability. – The endless discussions about the coming bear market in bonds is causing many investors to question whether bonds can still be used as an “anchor” within the context of a portfolio invested in stocks, bonds, and other asset classes.
Morningstar: – A better way to intrinsic value. – Focus on expected returns from conservatively forecast cash flows and not on the false precision of academic models, writes Morningstar’s Sam Lee.
WSJ: – Pimco rehires former senior executive Paul McCulley. – Pacific Investment Management Co. has rehired Paul McCulley, a former senior executive of the bond giant, as the firm tries to fill a void left when Mohamed El-Erian departed earlier this year.
WSJ: – Bond market flips the script on risk and reward. – For many bond investors this year, the reach for yield has come up short. Bonds perceived as safe have produced better returns than riskier ones for the first time since 2010.
Financial Post: – What Mr. Bond is telling the market. – There is no shortage of research out there trying to explain the big surprise of the year: the rally in bonds that has dragged the yield on the 10-year U.S. Treasury note down more than 50 basis points to 2.5%.
John Overstreet: – Stocks and bonds risk going parabolic. – There is an increasing likelihood that interest rates will decline significantly over the next two to three years. If rates decline, stocks are likely to move up with bonds. If falling long-term yields flatten the yield curve sufficiently, that could increase the risk of a market crash.
MarketWatch: – Janus launches unconstrained bond fund. – Janus Capital Group Inc. today announced the launch of the Janus Unconstrained Bond Fund that seeks to maximize total returns, consistent with the preservation of capital. The fund, which launched on May 27, 2014, will be managed by Janus Capital Management LLC.
Gross: McCulley is back @ PIMCO! Mr. ShadowBanking/Mr. MinskyMoment wl solidify&expand PIMCO’s New Neutral as Chief Economist. Welcome back!
— PIMCO (@PIMCO) May 27, 2014
Such a demand for credit with yield, brokers are begging people for paper
— David Schawel (@DavidSchawel) May 27, 2014
— Peter Tchir (@TFMkts) May 27, 2014