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On the face of it, US Treasury yields don’t seem to be playing ball at the moment. Conventional thinking holds that better economic data leads to expectations of higher short-term interest rates and that bond yields will rise as a result.
But 10 year Treasury yields, which move inversely to prices, briefly touched their lowest level in six months on Monday, despite signs the economy is improving and the Fed continuing to roll back its Quantitative Easing program.
But Steven Major, global head of fixed income research at HSBC says in today’s Financial Times that people are looking at this the wrong way around. We should be looking at “what the bond market says about the economy than what the economy should say about bond yields.”
“This ‘tail wagging the dog’ approach requires a closer look at three factors: what bond yields tell us; historical precedents for bonds moving independently of official rates; and what bond yields mean for the various actors in the economy.”
So what is the bond market telling us about the economy? “One year ago the U.S. Treasury five-year yield, starting in five years’ time (a key forward rate), was 2.8 per cent.” Says Major.
“By the end of 2013 the same forward yield was at 4.6 per cent, above the Fed’s long-run nominal GDP growth forecast, thereby reflecting much more restrictive financial conditions than a year earlier.”
“Stronger economic data and projections of higher official rates, most dramatically so in the UK and US, had already been factored into long forwards. Now at 3.90 per cent, there has been a return to the middle of the range established over the past 12 months.”
“Markets are now more comfortable with ‘buy the rumour, sell the fact’ says Major, “and there is statistical support for this independent movement of long yields, confirmed in a 2013 report by the St Louis Fed. The conclusion was that long yields were mostly driven by macroeconomic factors while the short rates were more influenced by monetary policy.”
“Longer-dated bond yields are lower than where they started the year partly because the overwhelming consensus has been positioned for higher yields. If the incoming data start to respond to last year’s tighter monetary conditions and expectations of tightening are priced-out, there is scope for intermediate-to-long yields to fall further.”
You can read Majors full article in today’s Financial Times.
Todays Other Top Stories
MuniNetGuide: – Michael Lewis and today’s muni market. – Despite Janet Yellen’s insistence in her testimony to Congress yesterday that much of the first quarter’s anemic growth is weather-related, the market is still convinced there is an undercurrent of economic weakness out there which is not entirely attributable to the Polar Vortex. As spring finally arrives in most parts of the country, we’ll soon find out if this belief is warranted.
Cate Long: – Bearish on Puerto Rico. – Analyst Charles Grant, praised the Puerto Rico government for its effort to pay its debts. But, given the commonwealth’s population decline and low labor participation rate of around 40 percent, he is unable to discern any long-term plan to right size the government’s debt load.
LearnBonds: – Auction rate securities – Meaning and risks. – Auction rate securities are debt instruments in which the interest rate is reset on a recurring basis through a Dutch auction. Auction rate securities help issuers diversify their funding structure by allowing them to pay at variable, short-term rates, compared to traditional bonds that pay a fixed, long-term rate.
NASDAQ: – Treasury bonds sizzle, high tech fizzles. – What do you get when you add up Twitter, Yelp, and Weibo? Answer: Deflation. That’s the latest joke as former high-flying tech stocks fizzle, while Treasury bonds sizzle.
Zero Hedge: – Two more theories to explain the “Treasury bond buying” mystery. – With everyone and their mom confused at how bonds can rally when stocks are also positive, we have seen Deutsche confused (temporary technicals), Bloomberg confirm the shortage, and BofA blame the weather (for a lack of bond selling). Today, we have two more thoughtful and comprehensive perspectives from Gavekal’s Louis-Vincent Gave (on why yields are so low) and Scotiabank’s Guy Haselmann (on why they’ stay that way).
Federated: – Bond market update: What’s up with Treasuries? – Despite the biggest jump in nonfarm payrolls in two years on Friday, longer-term bonds rallied and yields fell. Whats happening?
WSJ: – Treasury bonds boosted by Draghi comments. – Treasury bonds edged higher Thursday as the head of the European Central Bank signaled that it may roll out fresh monetary stimulus next month to keep interest rates low and support the economy.
High Yield Bonds
Bloomberg: – Yellen’s influence on the junk bond market. – Bloomberg’s Lisa Abramowicz discusses how markets are reacting to Federal Reserve Chair Janet Yellen’s testimony before the Joint Economic Committee in Washington.
FT: – Yield-hungry investors go into riskiest corner of U.S. bond market. – Investors hungry for high yielding assets are turning to one of the riskiest corners of the US corporate debt market, that of long-dated debt rated triple C, lured by the potential of stronger returns.
Citywire: – High yield star Lundie snaps up EM corporate debt. – Citywire A-rated manager Fraser Lundie has upped exposure to emerging market corporate high yield bonds.
FundWeb: – Flexible bond managers up emerging market debt exposure. – Bond fund managers with flexible mandates have started to shift money towards emerging market debt as this previously unloved asset class has started to show signs of attractive valuations.
Businessweek: – Smart money dumps emerging-market bond ETFs as yields decline. – Investors are pulling out of exchange-traded funds for emerging market bonds at the fastest pace since November after a three-month rally pushed down yields and dimmed the allure of the securities.
Donald van Deventer: – Berkshire Hathaway bonds: Good value, but not best value. – Berkshire Hathaway default probabilities rank in the best 3 percent of all insurance firms, but they are up slightly since September and ratings have been downgraded twice since 2010. Ranked by the credit spread to default probability ratio, BRK bonds rank in the top 20% of all bonds traded on May 5. Still 28 bonds offered a better credit spread to default probability ratio than the best bond of Berkshire Hathaway Finance Corporation.
WSJ: – Wealth Adviser: In Defense of long-term bonds. – With the prospect of interest rates rising, long-term bonds are seen by many as a bad bet. But that’s “a big lie that keeps being repeated,” argues bond specialist Stan Richelson. For retirees looking for a safe and predictable income stream, “long-term, high-quality bonds as still the best way to go” .
The Globe and Mail: – Fixed income’s new reality: Bonds are like stocks. – The new-age fixed income is more correlated to stocks, and therefore provides balanced portfolios with less downside protection. Default risk and leverage lead to higher returns in strong markets, but you reap less of the benefit of diversification in weak ones.
Chris Ciovacco: Vigilantes: – A balanced portfolio’s worst nightmare. – When bonds sell off, and interest rates spike, stocks and bonds can drop sharply in unison; something that may surprise those holding balanced portfolios.
Charles Sizemore: – Yes, yields are receding. No, you shouldn’t buy bonds. – I have advice for bond bears: Listen to Fed Chair Janet Yellen. When she tells us that she expects long-term bond yields to remain low, she means it. Yes, she’s tapering. But she’s also made it clear that she considers low yields essential to a sustainable economic recovery. I wouldn’t advise betting against her; she has a bigger wallet than you.
A Wealth of Common Sense: – Yes, stocks and bonds can rise together. – Some people have a misunderstanding of the correlation between stocks and bonds. They aren’t perfectly negatively correlated, which would mean one rises when the other falls. Stocks and bonds have close to a zero correlation historically, which means there is basically no relationship in their movements.
About.com: – Bond funds performing better than expected. – Most stock market observers and financial media pundits were calling for the death of bond mutual funds in 2014 and would have never predicted a positive return by this point in the year. Why are bond prices higher now than at the end of 2013?
FT: – Taper tremors fail to deter ETF investors. – Tremors that ran through the $2.5tn market for exchange traded funds last year have failed to deter investors from using the vehicles to trade junk bonds, says a report from Fitch Ratings.
Zacks: – 3 Long term bond ETFs surging as rates stay low. – Bond investing saw a trend reversal to start this year. While short-term bonds garnered investor attention last year, long-term bonds have started to captivate investors’ interest this year.
People aren’t really citing “harsh weather” for the UST rally, are they?
— David Schawel (@DavidSchawel) May 8, 2014
word of the day in the municipal market = “capitulation”…bears getting mauled — Michael Pietronico (@MillerTabak) May 8, 2014
Doubting the run in #municipal HY? Single-B United Airlines terminal deal just re-priced $300MM bonds 10bps lower in a little over an hour.
— Muni Market Advisors (@Muni_Mkt_Advis) May 8, 2014