On Wall Street
May 30, 2014 8:49 am
Supply and demand drive down US bond yields
Treasury issuance has dropped even as investors flock to bond funds
Supply and demand is a guiding principle of setting market prices. That dynamic may help explain why we have seen such a powerful rise in US bond prices, mirrored by a pronounced decline in long-dated Treasury yields.
There are plenty of fixed income investors struggling to reconcile the bullish behaviour of Treasuries with record US equity prices, improving second-quarter economic data and fewer central bank bond purchases.
Also playing a role has been a notable slowdown in the net issuance of bonds this year, led by US Treasuries, as the budget deficit has improved sharply.
Keith Parker, strategist at Deutsche Bank highlighted in research published this week how the net issuance of Treasury debt has fallen 59 per cent so far this year.
“People are trying to figure out what is driving bond yields and the decline in net supply is an under-appreciated factor,” he says, noting a similar story for US corporate bonds and the issuance of mortgage securities.
RBS Securities estimates global demand for high-quality bonds for 2014 will amount to $1.2tn, while actual net supply is only roughly $600bn. “Global demand is far in excess of supply,” says Edward Marrinan, head of macro credit at the bank. “It’s a far less complex story that explains the drop in yields.”
With investors pumping money into bond funds, the contraction in net issuance or sale of new bonds, in effect means there is less paper to satisfy demand that keeps growing from a variety of sources.
This week the Federal Deposit Insurance Corp said US banks boosted their holdings of US Treasuries 23 per cent during the first quarter, the largest expansion since the financial crisis. Awash with cash, banks are looking at bonds as a place to park money and their ownership of Treasuries is the highest since 1997.
Coupled with excess global savings, it should not be surprising that Treasury bonds are attracting buyers, particularly when long-dated US yields are much higher than those for Germany, France, Switzerland, the Netherlands and Japan. Also of note is that, while the Fed is tapering its Treasury purchases, it is still buying more long-term securities than when QE3 was announced in September 2012.
Declining net bond issuance comes at a time when a big chunk of the world’s population, the baby-boomer generation, has started retiring and begun searching for securities that provide a fixed rate of return and provide an element of capital preservation.
This was certainly evident at the start of 2014, with pension plans and insurers buying long-dated US bonds. A rotation away from equities towards fixed income was the initial spark in January for a significant outperformance by long-dated Treasuries and corporate bonds so far this year. Not since the second half of 2006, have 30-year Treasury yields fallen for five straight months.
John Brady, managing director at RJ O’Brien says: “There just aren’t enough high quality bonds, it’s not just pension funds, banks are big buyers too.”
Once the calendar flips over to June, the issuance story will alter says Mr Parker, who estimates net monthly issuance of Treasuries will more than double to $50bn through to the end of the year.
The prospect of the Fed’s taper ending in October, more corporate bond issuance thanks to a further rise in merger and acquisition activity, along with stronger US growth numbers, is likely to entail higher bond yields in the coming months.
Much, however, depends on whether the broad spectrum of US and global bond investors will greatly scale back their demand. If anything, the evidence suggests any move higher in bond yields will be brief as many will see it as a buying opportunity.
This week, Treasury prices staged another impressive performance, pushing benchmark 10- and 30-year yields down to their lowest levels in nearly a year.
The general view is that the bond rally reflects concerns over global growth prospects, a strong trend of low inflation and the idea, expressed in Pimco’s “new neutral” thesis, that future interest rate rises by the Federal Reserve, will be limited in scope due to weaker long-term prospects for the US economy.
Keith Parker, strategist at Deutsche Bank highlighted in research published this week how the net issuance of Treasury debt has fallen 59 per cent so far this year.
“People are trying to figure out what is driving bond yields and the decline in net supply is an under-appreciated factor,” he says, noting a similar story for US corporate bonds and the issuance of mortgage securities.
RBS Securities estimates global demand for high-quality bonds for 2014 will amount to $1.2tn, while actual net supply is only roughly $600bn. “Global demand is far in excess of supply,” says Edward Marrinan, head of macro credit at the bank. “It’s a far less complex story that explains the drop in yields.”
This week the Federal Deposit Insurance Corp said US banks boosted their holdings of US Treasuries 23 per cent during the first quarter, the largest expansion since the financial crisis. Awash with cash, banks are looking at bonds as a place to park money and their ownership of Treasuries is the highest since 1997.
Coupled with excess global savings, it should not be surprising that Treasury bonds are attracting buyers, particularly when long-dated US yields are much higher than those for Germany, France, Switzerland, the Netherlands and Japan. Also of note is that, while the Fed is tapering its Treasury purchases, it is still buying more long-term securities than when QE3 was announced in September 2012.
Declining net bond issuance comes at a time when a big chunk of the world’s population, the baby-boomer generation, has started retiring and begun searching for securities that provide a fixed rate of return and provide an element of capital preservation.
This was certainly evident at the start of 2014, with pension plans and insurers buying long-dated US bonds. A rotation away from equities towards fixed income was the initial spark in January for a significant outperformance by long-dated Treasuries and corporate bonds so far this year. Not since the second half of 2006, have 30-year Treasury yields fallen for five straight months.
Once the calendar flips over to June, the issuance story will alter says Mr Parker, who estimates net monthly issuance of Treasuries will more than double to $50bn through to the end of the year.
The prospect of the Fed’s taper ending in October, more corporate bond issuance thanks to a further rise in merger and acquisition activity, along with stronger US growth numbers, is likely to entail higher bond yields in the coming months.
Much, however, depends on whether the broad spectrum of US and global bond investors will greatly scale back their demand. If anything, the evidence suggests any move higher in bond yields will be brief as many will see it as a buying opportunity.
Copyright The Financial Times Limited 2014.
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