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The Wild Treasury Rally Actually Has Plenty of Naysayers

The Wild Treasury Rally Actually Has Plenty of Naysayers

(Bloomberg) -- As bond bulls rampage across Wall Street on recession fears, a cohort of investors is pushing back against the ferocious rally.

They’re citing a brewing backlash if the Federal Reserve cuts interest rates less than expected and the prospect of Chinese stimulus. Once you take into account the global savings glut, fears of economic doom ostensibly flashed by longer-dated bonds look overstated, the argument goes.

Their sanguine take offers a tentative reprieve for stock bulls torn apart by panic buying of government debt, as cross-asset volatility breaks out.

“Our view is that bonds will have to reprice more than equities,” said George Papamarkakis, chief investment officer at North Asset Management. “I’m short fixed income, mainly in the front-end. Based on the data we’ve got, there is no justification for the Fed to cut rates at the pace that’s priced in by the market.”

The Wild Treasury Rally Actually Has Plenty of Naysayers

Wall Street is entertaining recession scenarios as inflation and growth momentum go missing, while traders ramp up bets on multiple U.S. rate cuts this year. Last week’s bonanza of monetary-easing decisions in Asia along with renewed trade tensions helped drive yields on benchmark bunds to unprecedented levels, as Berlin pushes back on calls for fiscal stimulus.

It’s leaving bonds pricing in a material downturn at odds with a recent Bank of America fair-value estimate that puts 10-year Treasuries closer to 2.5%, some 84 basis points higher than current levels.

Papamarkakis says European growth can rebound thanks to monetary and fiscal support, especially from Beijing.

China’s credit growth slumped to the second-lowest amount this year in July on weak demand and seasonal factors, data on Monday showed, putting pressure on officials to ease policy.

That’s a big deal. Stephen Jen reckons Treasuries are tracking gyrations in Chinese credit and liquidity, or total social financing, and thereby issuing a signal on global momentum -- rather than a U.S. recession.

“If the main source of the global slowdown is policy restraint in China,’’ he wrote in a note last week. “And therefore the global slowdown is policy-induced rather than forced on by inadequate demand or financial breakages that are beyond policy makers’ control, then global growth will slow but not end. And the U.S. economy will continue to outperform.’’

The Wild Treasury Rally Actually Has Plenty of Naysayers

Another reason why investors shouldn’t see doom in tumbling long-dated U.S. yields? Secular demographic trends, according to Pimco’s Nicola Mai. “Low yields also partly reflect excess savings, partly because of demographics, partly because of risk aversion following the financial crisis,” he said. “All of that is leaving the equilibrium of rates lower than it used to be.”

PricewaterhouseCoopers LLP estimates that global assets under management, a proxy for savings, will rise to $145 trillion by 2025 from $84.9 trillion in 2016.

While Mai favors five-year U.S. bonds, the London money manager is underweight long-dated obligations ahead of a likely steepening in the Treasury curve. Pimco’s house view is that an imminent recession is unlikely thanks in part to the health of U.S. households and accommodative financial conditions.

The counterpoint comes from Barclays Plc. In a Thursday note, it advises clients to stay long government bonds citing surveys showing a weaker labor-market and business cycle.

Still, with fiscal and monetary tools in order, the U.S. economy isn’t cratering anytime soon, according to Mark Dowding, chief investment officer at BlueBay Asset Management.

“We would have a bearish bias on the direction of U.S. rates from here,” he said. “We continue to view a U.S. recession as very unlikely. There is a substantial likelihood that the Fed delivers less than what’s priced in.”

--With assistance from Yakob Peterseil.

To contact the reporter on this story: Anchalee Worrachate in London at aworrachate@bloomberg.net

To contact the editors responsible for this story: Samuel Potter at spotter33@bloomberg.net, Sid Verma, Cecile Gutscher

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