Bonds Investment TV

A year since 'taper tantrum,' bond market calm confounds investors

By Michael Santoli
Article from
Posted on Fri, May 9, 2014, 8:32pm EDT 

A year since the dramatic “taper tantrum,” the bond market is again confounding skeptical investors — but this time with its persistent composure and calm. 

In May of last year, Federal Reserve Chairman Ben Bernanke touched off a mini-panic in the Treasury market by describing his intention to gradually reduce the Fed’s pace of bond buying in response to firming economic conditions. In the harried anticipation of the “tapering” of the Fed’s quantitative-easing program, bond yields rushed higher, from below 1.7% early that month to 2.16% by May 31. 

The benchmark yield reached 2.98% around Labor Day — a wild and painful velocity of selling for the world’s most liquid market. The 10-year ultimately peaked at 3.02% on Dec. 31, and since has eased back toward 2.60%. 

From a wider view, the yield has spent more than 10 months lolling between 2.50% and 3%, upending popular expectations that yields would climb steadily higher and make bond investments treacherous. The consensus based this view on expectations of waning Fed support, a broad pickup in the world economy and a flow of investor dollars from bonds toward stocks. Of these firmly held premises, only the Fed’s well-telegraphed monthly reduction in bond-purchase volume has decisively come to pass. 

A 'flummoxed' market

“The market is flummoxed,” says William O’Donnell, co-head of markets strategy at RBS Securities. Hedge funds continue to bet on higher rates by shorting Treasury futures, and fund-manager surveys continue to show dislike for bonds.

And yet a variety of powerful forces have kept real money flowing into bonds, and their persistence will likely act as a shorter chain anchoring yields at lower levels than accompanied past economic cycles. 

Among the factors: 

The strong rebound in equity markets got pension funds fully funded and topped up their allocation to stocks, leaving them hungry to lock in long-term yields to fund future obligations and stoking a strong appetite for longer-term debt. Insurance companies and foreign central banks have followed this path, too. And U.S. banks have also become aggressive buyers of Treasuries as they seek safe “carry,” or interest-rate spread, income. 

In short, there hasn’t been much of a “great rotation” of cash from bonds into stocks, in large part because strong stock-market performance itself did investors’ rotating for them. 

The persistent demand for yield is meeting a relatively constrained supply of “interest rate” available in the world. In some respects, as reported here in February, there is a “bond shortage.”

Meantime, stimulative Japanese central bank bond buying and the widespread belief that the European Central Bank is committed to backstopping sovereign debt markets on the Continent have compressed foreign government yields to levels below what almost anyone expected. 

With German 10-year yields below 1.5% and those of Italy, Spain and Ireland beneath 3%, U.S. Treasuries just above 2.50% look like a downright cheap source of safe income by comparison. 

Investors are coming around to Fed Chair Janet Yellen’s message that, after the Fed sunsets its QE program – perhaps by October, possibly later – it will still be a relatively long time before short-term interest rates are lifted. The important point of Yellen’s recent line of communication is that short-term interest rates will ultimately peak at far lower levels than in past “normal” economic cycles. 

Michael Darda, strategist at MKM Partners, now forecasts short-term rates will be lifted only to 2% to 3% at this business-cycle peak, some years down the road, compared to 4% or higher in pasty tightening phases. In this respect, this cycle resembles those immediately after World War II, when long-term rates were rather steady at low levels for years on end. In the late ‘40s and ‘50s, benchmark Treasury yields peaked between 2.4% and 3.9%. 

The U.S. economy’s perceived chances of surging toward “escape velocity” have diminished in recent months. The first quarter’s leaden 0.1% early reading on GDP means the math for getting to 3% for the full year has become challenging. This dampens fears that inflation pressures will build as economic slack is reduced quickly, and makes investors more comfortable owning bonds. 

All this goes a long way toward explaining why rates have been suppressed, and why, in turn, corporate bonds and all other debt products have been enjoying huge demand. It doesn’t mean bonds are a great buy at these levels, or that rates won’t drift higher. But a surge in rates seems less likely than the conventional wisdom continues to hold. 

O’Donnell believes 10-year Treasury yields will stay roughly in their recent range, meaning traders can lighten up on bonds near the current lower end of the range and look to buy as yields get closer to 3%. He thinks a likely, though fleeting, catch-up move in the Fed’s preferred inflation measure – personal consumption expenditures – this month could jar yields a bit higher. But he would view that as a chance for tactical investors to add a bit more exposure to Treasuries, which have so far refused to comply with those popular calls to throw another tantrum.

Michael Santoli
Article from
Posted on Fri, May 9, 2014, 8:32pm EDT 

Wall Street Week Ahead-Bond, stock investors making hay; can both be right?

By Rodrigo Campos
NEW YORK Fri May 2, 2014 6:27pm EDT
Article from

(Reuters) - With U.S. stocks near record highs and Treasury bond yields near multi-month lows, the disconnect between equity and debt investors has rarely been as stark. Over the coming months, the economy is likely to show one of the groups has bet wrong.

The S&P 500 .SPX sits less than one percent below an all-time high. After a wintry first quarter, stock investors are betting that economic growth is picking up, as evidenced by stronger spending figures and business demand. That's boosted the cyclical stocks which react to rising demand, particularly energy shares.

"The data are suggesting this may be the year when we turn the corner," said Quincy Krosby, market strategist at Prudential Financial in Newark, New Jersey.

"If data continues to gain traction you're going to see investors turn to more cyclical parts of the market. And I think that's already started."

Bond investors are reacting to a different story. Yields on the 10-year note hit a five-month low on Friday and the 30-year note's yield fell to its lowest since June after the April jobs report, which showed strong growth in payrolls but no growth in earnings and a decline in the labor force.

That data points to the conclusion that overall economic demand will remain tepid and that inflation won't materialize as the Federal Reserve continues to pull back on monetary stimulus, analysts said.

"Fixed income investors are slowly waking up to the reality that as the Fed steps back from quantitative easing, there are no signs of inflation," wrote Andrew Wilkinson, chief market analyst at Interactive Brokers in Greenwich, Connecticut, in a note.

Bonds are also gaining as concern about the Ukraine-Russia crisis heightens the safe-haven appeal of U.S. debt, while some corporate pension funds are increasingly shifting to bonds as they seek to match their holdings to the liabilities they are going to face.

Still, the rise in equity markets doesn't mean that investors are as confident about growth stocks as they were in 2013. The strongest sector in 2014 is utilities, which have gained 14 percent and are generally associated with safety. Consumer discretionary shares such as are down 4.2 percent, the worst-performing sector so far this year.

This may be changing. Data show that the latest internal rotation in stocks has seen the energy sector take the lead, with a 4.2 percent gain over the last month.

Capacity utilization, a measure of how much industrial power is being put to work, rose last month to its highest in nearly six years and is expected to have ticked higher in the April report, while Fed data showed last week that commercial and industrial loans grew at a steady pace in April.

This makes it entirely possible that the bond market - generally the more sober-minded of the two markets - may have it wrong.

"We believe that the current pricing in the Treasury market has insufficiently accounted for the potential for an explosion in GDP growth," said Millan Mulraine, deputy head of U.S. research and strategy at TD Securities USA in New York in a research note.

(Reporting by Rodrigo Campos; additional reporting by Jennifer Ablan and Jonathan Spicer. Editing by David Gaffen and John Pickering)

Rodrigo Campos
NEW YORK Fri May 2, 2014 6:27pm EDT
Article from

Wall Street Bond Dealers Whipsawed on Bearish Treasuries Bet

By Lisa Abramowicz and Daniel Kruger Apr 22, 2014 12:01 AM GMT+0800

Betting against U.S. government debt this year is turning out to be a fool’s errand. Just ask Wall Street’s biggest bond dealers.

While the losses that their economists predicted have yet to materialize, JPMorgan Chase & Co. (JPM), Citigroup Inc. (C) and the 20 other firms that trade with the Federal Reserve began wagering on a Treasuries selloff last month for the first time since 2011. The strategy was upended as Fed Chair Janet Yellen signaled she wasn’t in a rush to lift interest rates, two weeks after suggesting the opposite at the bank’s March 19 meeting.

The surprising resilience of Treasuries has investors re-calibrating forecasts for higher borrowing costs as lackluster job growth and emerging-market turmoil push yields toward 2014 lows. That’s also made the business of trading bonds, once more predictable for dealers when the Fed was buying trillions of dollars of debt to spur the economy, less profitable as new rules limit the risks they can take with their own money.

“You have an uncertain Fed, an uncertain direction of the economy and you’ve got rates moving,” Mark MacQueen, a partner at Sage Advisory Services Ltd., which oversees $10 billion, said by telephone from Austin, Texas. In the past, “calling the direction of the market and what you should be doing in it was a lot easier than it is today, particularly for the dealers.”

On March 31, Federal Reserve Chair Janet Yellen highlighted inconsistencies in job data... Read More

Treasuries (USGG10YR) have confounded economists who predicted 10-year yields would approach 3.4 percent by year-end as a strengthening economy prompts the Fed to pare its unprecedented bond buying.

Caught Short

After surging to a 29-month high of 3.05 percent at the start of the year, yields on the 10-year note have since declined and were at 2.7 percent at 11:55 a.m. in New York.

One reason yields have fallen is the U.S. labor market, which has yet to show consistent improvement.

The world’s largest economy added fewer jobs on average in the first three months of the year than in the same period in the prior two years, data compiled by Bloomberg show. At the same time, a slowdown in China and tensions between Russia and Ukraine boosted demand for the safest assets.

Wall Street firms known as primary dealers are getting caught short betting against Treasuries.

They collectively amassed $5.2 billion of wagers in March that would profit if Treasuries fell, the first time they had net short positions on government debt since September 2011, data compiled by the Fed show.

‘Some Time’

The practice is allowed under the Volcker Rule that limits the types of trades that banks can make with their own money. The wagers may include market-making, which is the business of using the firm’s capital to buy and sell securities with customers while profiting on the spread and movement in prices.

While the bets initially paid off after Yellen said on March 19 that the Fed may lift its benchmark rate six months after it stops buying bonds, Treasuries have since rallied as her subsequent comments strengthened the view that policy makers will keep borrowing costs low to support growth.

On March 31, Yellen highlighted inconsistencies in job data and said “considerable slack” in labor markets showed the Fed’s accommodative policies will be needed for “some time.”

Then, in her first major speech on her policy framework as Fed chair on April 16, Yellen said it will take at least two years for the U.S. economy to meet the Fed’s goals, which determine how quickly the central bank raises rates.

After declining as much as 0.6 percent following Yellen’s March 19 comments, Treasuries have recouped all their losses, index data compiled by Bank of America Merrill Lynch show.
Yield Forecasts

“We had that big selloff and the dealers got short then, and then we turned around and the Fed says, ‘Whoa, whoa, whoa: it’s lower for longer again,’” MacQueen said in an April 15 telephone interview. “The dealers are really worried here. You get really punished if you take a lot of risk.”

Economists and strategists around Wall Street are still anticipating that Treasuries will underperform as yields increase, data compiled by Bloomberg show.

While they’ve ratcheted down their forecasts this year, they predict 10-year yields will increase to 3.36 percent by the end of December. That’s more than 0.6 percentage point higher than where yields are today.

“My forecast is 4 percent,” said Joseph LaVorgna, chief U.S. economist at Deutsche Bank AG, a primary dealer. “It may seem like it’s really aggressive but it’s really not.”

LaVorgna, who has the highest estimate among the 66 responses in a Bloomberg survey, said stronger economic data will likely cause investors to sell Treasuries as they anticipate a rate increase from the Fed.

History Lesson

The U.S. economy will expand 2.7 percent this year from 1.9 percent in 2013, estimates compiled by Bloomberg show. Growth will accelerate 3 percent next year, which would be the fastest in a decade, based on those forecasts.

Dealers used to rely on Treasuries to act as a hedge against their holdings of other types of debt, such as corporate bonds and mortgages. That changed after the credit crisis caused the failure of Lehman Brothers Holdings Inc. in 2008.

They slashed corporate-debt inventories by 76 percent from the 2007 peak through last March as they sought to comply with higher capital requirements from the Basel Committee on Banking Supervision and stockpiled Treasuries instead.

“Being a dealer has changed over the years, and not least because you also have new balance-sheet constraints that you didn’t have before,” Ira Jersey, an interest-rate strategist at primary dealer Credit Suisse Group AG (CSGN), said in a telephone interview on April 14.

Almost Guaranteed

While the Fed’s decision to inundate the U.S. economy with more than $3 trillion of cheap money since 2008 by buying Treasuries and mortgaged-backed bonds bolstered profits as all fixed-income assets rallied, yields are now so low that banks are struggling to make money trading government bonds.

Yields on 10-year notes have remained below 3 percent since January, data compiled by Bloomberg show. In two decades before the credit crisis, average yields topped 6 percent.

Average daily trading has also dropped to $551.3 billion in March from an average $570.2 billion in 2007, even as the outstanding amount of Treasuries has more than doubled since the financial crisis, according data from the Securities Industry and Financial Markets Association.

“During the crisis, the Fed went to great pains to save primary dealers,” Christopher Whalen, banker and author of “Inflated: How Money and Debt Built the American Dream,” said in a telephone interview. “Now, because of quantitative easing and other dynamics in the market, it’s not just treacherous, it’s almost a guaranteed loss.”

Trading Revenue

The biggest dealers are seeing their earnings suffer. In the first quarter, five of the six biggest Wall Street firms reported declines in fixed-income trading revenue.

New York-based JPMorgan, the biggest U.S. bond underwriter, had a 21 percent decrease from its fixed-income trading business, more than estimates from Moshe Orenbuch, an analyst at Credit Suisse, and Matt Burnell of Wells Fargo & Co.

Citigroup, whose bond-trading results marred the New York-based bank’s two prior quarterly earnings, reported a 18 percent decrease in revenue from that business. Credit Suisse, the second-largest Swiss bank, had a 25 percent drop as income from rates and emerging-markets businesses fell. Declines in debt-trading last year prompted the Zurich-based firm to cut more than 100 fixed-income jobs in London and New York.

Chief Financial Officer David Mathers said in a Feb. 6 conference call that Credit Suisse has “reduced the capital in this business materially and we’re obviously increasing our electronic trading operations in this area.”

Bank Squeeze

Jamie Dimon, chief executive officer at JPMorgan, also emphasized the decreased role of humans in the rates-trading business on an April 11 call as the bank seeks to cut costs.

About 49 percent of U.S. government-debt trading was executed electronically last year, from 31 percent in 2012, a Greenwich Associates survey of institutional money managers showed. That may ultimately lead banks to combine their rates businesses or scale back their roles as primary dealers as firms get squeezed, said Krishna Memani, the New York-based chief investment officer of OppenheimerFunds Inc., which oversees $79.1 billion in fixed-income assets.

“If capital requirements were not as onerous as they are now, maybe they could have found a way of making it work, but they aren’t as such,” he said in a telephone interview.

To contact the reporters on this story: Lisa Abramowicz in New York at; Daniel Kruger in New York at

To contact the editors responsible for this story: Dave Liedtka at Michael Tsang

Lisa Abramowicz and Daniel Kruger Apr 22, 2014 12:01 AM GMT+0800