Bond Bears Chased Off as Dreams of 4% Treasury Yields Vanish
Tilting at Windmills of 4% Treasury Yield Becomes Fool's Errand
(Bloomberg) -- Conviction and the courage to show one’s mettle in the face of adversity are valued everywhere, perhaps no more so than in the investment community. Yet in the $15.9 trillion U.S. Treasury market, it’s increasingly looking like a fool’s errand to remain a bond bear.
In a surprise to many, U.S. bonds have been a winning long trade in 2019. The Bloomberg Barclays U.S. Treasury Index has gained 3.6%, while a separate index of global sovereign debt is up 2.2%. That’s bad news for a legion of investors, at firms like Franklin Templeton and Loomis Sayles & Co., who had built up bearish positions on government securities. The gains have sent the 10-year yield to 2.24%, the lowest since 2017 and down a percentage point since peaking in October.
“It’s really hard to maintain a bearish view on the Treasury market here,” said Nils Overdahl, a senior portfolio manager at New Century Advisors in Chevy Chase, Maryland. “You’d have to be a very brave soul to do so. It looks like the next move will be closer to 2%” for the 10-year note yield.
Former President Bill Clinton’s political adviser James Carville famously said he wished to be reincarnated as the bond market because of its power over policy makers and politicians, yet the “Ragin’ Cajun” made no inkling of a desire to time its moves. That’s a luxury investment managers don’t have now as 10-year benchmark rates plunge, making many investors wonder if they’ll even stop at 2% -- and if the bond market will start exerting that famous influence over Federal Reserve interest-rate policy.
Not too long ago, JPMorgan Chase & Co. Chief Executive Officer Jamie Dimon and Loomis Sayles fund manager Dan Fuss were among those seeing a path to 4% amid buoyant economic growth and a restrictive Federal Reserve. Ten-year Treasury yields were as high as 3.26% in October. After rising earlier today, they were down 2 basis points at less than 2.24% as of 1:40 p.m. in New York.
Fuss, the 85-year-old vice chairman of Loomis Sayles, is throwing in the towel on 4%. The trajectory in rates has fundamentally changed now that a near-term trade deal between the U.S. and China looks increasingly unlikely, Fuss said. The uncertainty is tying the hands of policy makers at the Fed and other major central banks as they brace for the expected economic hit from the trade war.
“In October, I had thought for sure, here we go -- even as the Trump administration will complain -- the Fed will proceed with their game plan of moving interest rates up and the 10-year yield will top out at roughly 4%,” Fuss said Wednesday by phone. “That was, unless something went bananas with the trade war. Well, guess what?”
It went bananas.
This backdrop has sent a key slice of the yield curve, which is closely watched as a gauge of an impending recession, further into inversion as traders ramp up bets the Fed will actually cut their target rate in 2019.
Still, not everyone is reversing course.
Some futures traders continue to hold bearish positions on bonds, with speculators adding to short bets and asset managers this month scaling back long positions. Hedge funds and other large speculators have had net bearish 10-year Treasury positions all year, according to Commodity Futures Trading Commission data through the week ended May 21.
As of the end of March, Michael Hasenstab had been loading up on interest-rate swaps in the $34 billion Templeton Global Bond Fund he manages in order to deepen an ultra-short exposure to duration, a measure of sensitivity to shifts in yields. The fund’s average duration has dropped every quarter for the past two years and stood at minus 2.21 years, according to filings. The fund doesn’t disclose holdings information in between quarterly filings.
The fund has slumped 1.3% in the past month, underperforming more than 80% of peers, according to data compiled by Bloomberg.
In comments made to Bloomberg News in February, Hasenstab forecast that the Fed would keep raising interest rates this year as U.S. labor markets remain “exceptionally strong” while wages and inflationary pressures continue to rise. In October, Hasenstab said 10-year yields could “easily get above 4%.” That wager, along with big investments in select emerging markets, helped the Templeton Global bond fund post a 1.3% gain in 2018, compared with a loss for the FTSE World Government Bond Index.
At the moment, the main variables that bond wonks use to compute yields -- growth and inflation expectations, the outlook for monetary policy and how much extra compensation investors require to hold long-term bonds (dubbed term premium) -- all signal trouble for bond bears, according Jim Caron, fixed-income portfolio manager at Morgan Stanley Investment Management.
“The four factors that go into the basic construct of where 10-year yields will go all have a red arrow pointing down,” Caron said. “Yields are going lower.”
Worldwide demand for U.S. government debt has pushed the 10-year Treasury term premium to a record low of negative 0.84 percentage point as of May 28. The measure is a proxy for the extra compensation investors require to own the maturity rather than rolling over a shorter-dated obligation.
As for Jamie Dimon’s remarks about a 4% yield, JPMorgan spokesman Brian Marchiony had no comment. However, Dimon -- who obviously doesn’t personally make his living trading bonds -- has been clear that projecting the path of rates is a bit of a crystal-ball exercise.
“The notion that we know exactly what’s going to happen is wrong,” Dimon said in an interview with Bloomberg TV on May 8.
To contact the reporters on this story: Liz Capo McCormick in New York at emccormick7@bloomberg.net;Natasha Doff in Moscow at ndoff@bloomberg.net
To contact the editors responsible for this story: Benjamin Purvis at bpurvis@bloomberg.net, ;Cecile Gutscher at cgutscher@bloomberg.net, Michael P. Regan, Nick Baker
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