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Treasury Investors See Plenty of Reasons for Staying Under 5%

(Bloomberg) -- If you concentrate on the spirit of Jamie Dimon’s statement on Treasury yields rather than the 5 percent figure he says is possible, it’s easy to see why U.S. long-term rates should be higher.

All else equal, it seems investors probably should be demanding a bigger return on government bonds. After all, the Federal Reserve is committed to further rate hikes, the S&P 500 is the highest since January, the U.S. economy is growing at a 4 percent clip and headed into overdrive with tax cuts, and Treasuries supply is thundering down the pipeline.

But investors in Treasuries due in a decade aren’t fixating purely on today’s macro environment; they’re extrapolating it for the longer term. And far from snubbing 3 percent, they’re buying every time the benchmark pops above that level.

"A lot of things have to change for 5 percent," Priya Misra, head of global rates strategy at TD Securities in New York, said in a Bloomberg TV interview. Labor-force participation and productivity would have to increase, she said, and global rates would have to look slightly more competitive -- an unlikely prospect when comparable German and Japanese yields remain well below 1 percent.

Explanations Abound

The global search for yield is one driver of demand for Treasuries. But there are plenty of opportunities for a rate of around 5 percent on 10-year debt -- say local-currency Peru obligations, or dollar-denominated Russian government bonds -- for investors comfortable with the risk.

Risk aversion is helping keep the U.S. benchmark pinned around 3 percent. First, there’s the potential for policy missteps. On the fiscal side, investors see the U.S. government pushing the economy into high gear in the 10th year of expansion, and the potential for an overheating and recession doesn’t seem too remote in the next decade.

On the monetary side, central banks are poised to reverse policies that have suppressed volatility and depressed interest rates for the past decade. Add to that the risk that the trade war could get worse before it gets better. Market prices are currently building in the likelihood of only a couple more hikes, and the potential for cuts further down the track.

"If you look at the history of Fed policy, you see the Fed typically takes an escalator up and an elevator down,” said Matthew Hornbach, global head of interest-rate strategy at Morgan Stanley.

And even if investors aren’t worrying about all these things, they may simply be confident that the trend of tame inflation will persist. Despite speculation -- including from Dimon himself -- that the Fed could bungle its policy normalization, the current level of Treasuries suggests investors trust policymakers to keep price pressures in hand.

©2018 Bloomberg L.P.