Bond bears collide with swaps showing low rates for 2 years

‘Huge Losses’

The MOVE Index, which measures volatility based on prices of over-the-counter options on Treasuries maturing in two to 30 years, ended last week at 55. While that’s up from a record low of 51 on Dec. 3, it’s down from a post-financial crisis peak of 264.6 on Oct. 10, 2008 and below the average of about 100 since the beginning of 2000.

“The Fed’s debt purchases are helpful on the margin, but to a lot of people in the bond market the rate guidance is more important,” James Evans, a senior vice president at New York- based Brown Brothers Harriman & Co. who helps oversee $15 billion in fixed-income assets, said in a March 1 telephone interview. “That’s more so what’s keeping Treasury yields low.”

Not everyone agrees. Michael Schumacher, the head of global-rates strategy at UBS AG, says investors will face “huge losses” from a “big jolt” in yields when the Fed reduces its support. UBS is one of the 21 primary dealers of U.S. government securities that trade with the Fed and are obligated to bid at the Treasury’s debt auctions.

Fed’s Assets

The central bank’s balance sheet swelled to more than $3 trillion as of Feb. 21, including $1.74 trillion of Treasuries securities, $74.6 billion of Federal agency bonds and $1.03 trillion of mortgage-backed debt, central bank data show.

Investors should buy five-year Treasuries and avoid longer- term bonds, which would lose the most value when all the new money created by the Fed begins to spark inflation, Bill Gross, who runs the world’s biggest bond fund at Pacific Investment Management Co., wrote on Twitter Feb. 8.

Asset-price “irrationality” is rising after years of record low Fed rates, he wrote on Feb. 27 in his monthly investment outlook posted on Newport Beach, California-based Pimco’s website.

Instead of raising their yield forecasts, economists and strategists have steadily lowered them over time. The median of or more than 50 estimates in a Bloomberg survey is for 10-year yields to trade at 2.25% at year-end, lower than the 3%  that was predicted in April 2012.

Losses Trimmed

Last week’s rally helped Treasuries trim losses for the year to 0.23% from as much as 1.13% on Feb. 13, according to Bank of America Merrill Lynch’s U.S. Treasury Index. U.S. government debt returned 2.16% in 2012, including reinvested interest.

Hedge funds and other large speculators raised their bets that 10-year Treasuries will rally to the most this year. The difference in the number of bets on a gain and those on a decline rose to 115,908 contracts as of Feb. 26, according to U.S. Commodity Futures Trading Commission data.

Tax increases that went into effect Jan. 1 and $85 billion of government budget cuts means the economy will probably slow this year. Gross domestic product may expand 1.8% in 2013, down from 2.2% in 2012, according to the median estimate of more than 75 economists surveyed by Bloomberg.

“The Fed is not going to stop buying bonds anytime soon because the economy is just not there yet, it hasn’t reached escape velocity,” Richard Gordon, a fixed-income market strategist at Wells Fargo & Co. in Charlotte, North Carolina, said in a Feb. 28 interview. “We just don’t have any real inflationary pressures.”

Bloomberg News

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