U.S. TREASURY BEARS FACE IRRESISTIBLE FORCE / THE FINANCIAL TIMES COMMENT & ANALYSIS

On Wall Street

August 15, 2014 9:15 am

US Treasury bears face irresistible force

By Michael Mackenzie in New York

Expectations of rising bond yields keep being confounded

Persistently low yielding US government bonds show little sign of reversing course.

This is much to the chagrin of many investors who believe higher interest rates surely beckon and whose portfolios remain orientated towards such an outcome.

Expectations that Treasury yields should rise rather than keep grinding lower reflects the inherent optimism and impatience among numerous strategists and investors.

At this stage of the economic cycle we should be seeing a stronger economy accompanied by rising wages for workers, especially six years on from the depths of the financial crisis and after massive monetary stimulus from the Federal Reserve.

Except, little seems able to arrest the gravitational pull lower on long-term Treasury yields, which move inversely to price.

Worries that inflation looms large given the vast expansion of the Fed’s balance sheet in recent years has become a little like the tale of the ‘boy who cried wolf’.

Record equity prices and robust gains for other asset classes have not prompted a wholesale rotation out of US government bonds, even when the Fed’s monthly purchases of Treasuries have been declining and end in October.

In fact, many people keep buying Treasuries, and not just short-dated securities that benefit as a haven when geopolitical risk dominates the headlines.

Certainly, there was no shortage of buyers for this week’s sale of long-term Treasury paper, notably the 30-year bond, and for good reason. From a global perspective, US Treasury yields are appealing when benchmark German Bunds have broken below 1 per cent and seem set to follow the trail blazed by Japan and Switzerland.

No matter, bond bears and some in the strategist community are pinning their hopes on Treasury prices finally taking a long anticipated tumble that pushes yields upwards after central bankers venture west for their annual gathering in Jackson Hole, Wyoming, next week and the Fed’s July meeting minutes are released.

In the past, Jackson Hole has enabled Fed officials to signal policy shifts and none matters more to the bond market than some sign of when the central bank will finally end nearly six years of near zero official overnight borrowing rates.

In a summer marked by subdued activity, many on Wall Street are longing for some snippet from the Fed that summons volatility, generating a trading opportunity.

“We need a Fed-related spark to get things moving,” says John Briggs at RBS Securities, who adds bearish Treasury investors have been “fighting a losing battle this year”.

That forlorn cause, however, may well continue running for a while yet. The behaviour of bond yields suggests the prospect of the US economy sustaining a higher rate of growth matched by rising wages and inflation remains well beyond the horizon. The release of flatlining retail sales for July this week was hardly an encouraging sign.

And two-year Treasury note yields, a barometer of future policy expectations, have eased back to around 0.40 per cent from 0.55 per cent in recent weeks.

For all the angst in some quarters about rising consumer prices, expectations of future inflation have also been retreating.

“People want more excitement and drama, but we’ve been talking about the first rate hike for the past 18 months and it may still be a year away,” says David Ader at CRT Capital.

While there is a risk that Fed officials could well say something at Jackson Hole that ignites the bond market, a more likely result is that the planned discussion of the US labour market will simply dig deeper into what the Fed’s policy statement from July highlighted: “A range of labour market indicators suggests that there remains significant underutilisation of labour resources.”

Hardly the ammunition for a sharp bond market sell-off, no matter the bullish chatter from economists highlighting how US monthly job creation has averaged 230,000 so far this year.

A dovish Fed and resolute global demand for US Treasuries translates into yields staying low far longer than many think possible.

Copyright The Financial Times Limited 2014.