Investors fast running out of options
Turning point for bonds
U.S. treasury yields are rising at a pace not seen since before the financial crisis and with yields on government debt in Canada and elsewhere around the world following suit, bond investors are just as fast running out of options.
“The jump in U.S. Treasur y yields this week marks a secular turning point for bond markets,” said analysts at UBS AG. “We believe a long-term bear market has commenced.”
The frantic sell-off south of the border over the past week includes nine straight days of losses through Tuesday, pushing the yield on 10year treasuries as high as 2.4%, its highest level since October 2011 and well above the record low of 1.67% set in late September. The last time yields rose consecutively for this long was 2006.
The source of the selling can be traced to the Federal Open Market Committee’s latest statement on March 13 that confirmed the improving U.S. economy and likelihood that the U.S. Federal Reserve’s quantitative easing efforts are all but done.
“In concert with the strong rise in equities in 2012, investors are shifting money from bonds to equities to benefit from the economic recovery,” John O’connell, strategist at Macquarie Securities Limited said.
The sell-off is not contained to the U.S. either, Mr. O’connell added, noting 10-year yields in Canada, Germany, the United Kingdom and Australia have all risen by around 30-35 basis points over the last week.
“We saw U.S. bond yields rise by a similar amount in October, but other markets did not follow last time,” he said.
Investors are shifting money from bonds to equities to benefit from the economic recovery
UBS economist Stephane Deo said a sustainable U.S. recovery points to a bear market for bonds, particularly when combined with growth in China and overall emerging economies, and the Eurozone recession now posing fewer risks to the rest of the world economy.
“If the capacity of the European crisis to cause problems has indeed waned, that would allow Treasury yields to rise,” he said.
By extension, Mr. Deo expects German bunds, the most widely- held European debt security, to also rise higher. While the correlation between bunds and treasuries is sometimes quite unstable, he said it is “high and steady” in excess of 80% for 10-year and longer maturuties.
“This is fine, but it would suggest that the bund sell-off is just collateral damage from the Treasury move that has nothing to do with European fundamentals,” he said. “But we would argue this view is not correct: From a fundamental point of view, we believe the level of bund yields is way too low; if there is a normalisation of market conditions, fundamentals would also suggest a bund sell-off.”
Given that U.S. treasuries are trading more than 100 basis points below their high in 2001 of 3.77% their average of 3.87% over the past decade, many other analysts agree that government bonds have further to fall in the coming weeks. But not everyone is willing to concede a new bear market has begun — something which has been predicted often in the past few years but each time to no real avail.
“U.S. bond yields should remain relatively low as long as the Fed is expected to keep official interest rates near zero and euro breakup risks remain high,” said Julian Jessop, an economist at Capital Economics.