The biggest investors in Asia and Europe are keeping their money in Treasuries even after the steepest two-month loss for the securities erased $317 billion of market value.
Mizuho Asset Management Co., which oversees $32 billion, added Treasuries due in 10 years (CBOT:ZN.C) or longer to its holdings in the past month. HSBC Private Bank, with $480 billion in assets, bought U.S. notes when 10-year yields rose to 2.5%. Deutsche Asset & Wealth Management, which manages about $1.3 trillion, is holding debt maturing in less than four years, betting American interest rates will remain subdued.
After doubling holdings of Treasuries to $5.6 trillion in the past five years, overseas investors are resisting the market’s 3.2% slump in May and June and last month’s record $79.8 billion of withdrawals from bond funds. Since the Federal Reserve signaled it may slow the pace of asset purchases this year, the world’s biggest and most-actively traded debt market now offers the highest yields relative to other developed nations in three years.
“It’s the most liquid market in the world,” Yoshiyuki Suzuki, the head of the fixed-income department in Tokyo at Fukoku Mutual Life Insurance Co., which oversees $57.1 billion in assets, said in a phone interview on July 2. “The market has been volatile and some investors may not like it, but there is no reason to avoid U.S. Treasuries. The current movement is an overreaction.”
Suzuki said he purchased Treasuries maturing in about 10 years in May, and added to that position in late June.
Benchmark 10-year note yields rose to 2.74% last week from this year’s low of 1.61% on May 1. The price of the 1.75% security due in May 2023 fell 2 2/32, or $20.63 per $1,000 face amount, to 91 1/2 last week.
The yield rose to as high as 2.75% today before dropping seven basis points, or 0.07 percentage point, to 2.67% at 10:03 a.m. New York time.
Yields have risen 32 basis points since June 19, when Fed Chairman Ben S. Bernanke said policy makers may begin to reduce $85 billion in monthly bond purchases should the world’s largest economy meet the central bank’s goals. The average yield in the past five years was 2.74%.
Treasuries maturing in 10 years and more yielded 85 basis points more than non-U.S. sovereign debt on July 5, according to Bank of America Merrill Lynch indexes. Similar maturity non-U.S. government debt yielded more a year earlier.
Benchmark U.S. 10-year notes yielded 102 basis points more than similar-maturity German bonds on July 5, the most since July 2006. The spread with U.K. gilts rose to 25 basis points on July 5. As recently as January, U.S. Treasuries yielded 23 basis points less than British government bonds.
“Yields are now getting closer to a level that we are comfortable with,” Willem Sels, the London-based U.K. head of investment strategy at HSBC Private Bank, said in a July 3 phone interview. “Treasury rates may head higher in a longer run, but we don’t envisage a bond bear market scenario. We are not as optimistic as the Fed in terms of growth outlook. Therefore, we think that it’s likely the extreme spike is behind us.”
While the Fed may be preparing to cool quantitative easing asset purchases, other central banks are ready to step up stimulus. European Central Bank President Mario Draghi said last week that there are no plans to end its low-rate policy until economic recovery is assured. The Bank of Japan announced plans to double the monetary base in two years.
The ECB kept its benchmark interest rate at 0.5%. In the U.S., the Fed’s target for overnight loans between banks has remained at zero to 0.25% since the end of 2008.
“We interpret this tremendous increase in yield as an overreaction to Bernanke’s statement,” Yusuke Ito, a money manager at Mizuho Asset Management in Tokyo, said in a phone interview on July 2. The Fed said “it will slow down quantitative easing, not raise interest rates,” Ito said. “The market is expecting an interest-rate hike to come soon. We don’t think that is going to happen. We are positive on Treasuries.”
MEAG Munich Ergo Asset Management GmbH’s Reiner Back, who helps oversee $305 billion as head of fixed income and foreign exchange in Munich, said July 3 that he remains positive on Treasuries. The increase in yields has “re-established value,” he said.
Deutsche Asset & Wealth Management in Frankfurt favors shorter-term notes, betting that subdued inflation will deter the Fed from raising rates before 2015. Amundi Asset Management, which has an equivalent of $970 billion in assets, said it would consider 10-year Treasuries “on a tactical basis” if yields approach this year’s highs.
The threat of reduced bond buying by the Fed caused the $10.5 trillion Treasuries market to lose 2% in May, the worst month since December 2009. It fell another 1.3% in June, according to a Bank of America Merrill Lynch index.
Investors who poured $1.26 trillion into bond funds in the past six years pulled $70.8 billion from mutual funds, typically owned by individuals, last month through June 27, according to TrimTabs Investment Research. They withdraw $9 billion from exchange-traded funds, which both institutional and private investors buy, in the same period.
Japanese investors sold a record 3 trillion yen ($29.7 billion) in May, figures from the nation’s Ministry of Finance showed today, the most in data going back to 2005.
Yields don’t reflect the improving U.S. economic outlook, according to Paris-based Carmignac Gestion SA, which oversees $70 billion. Policy makers on June 19 raised their growth forecasts for next year to a range of 3% to 3.5% and reduced their prediction for unemployment to as low as 6.5%. The growth forecast is higher than the 2.7% expansion estimate of economists in a Bloomberg News survey.
Employment increased more than forecast in June, with payrolls climbing by 195,000 workers for a second straight month, the Labor Department reported on July 5.
“U.S. rates are going to normalize and will grind higher,” Sandra Crowl, a member of Carmignac’s investment committee, said in a phone interview on July 3. “Rates in the U.S. as they stand currently are too low for the growth level, because of the effect of the quantitative easing.”
The money manager expects 10-year rates to rise to about 3% by the end of the year and owns a smaller percentage of Treasuries than is recommended by its benchmarks, she said.
With yields this low, some investors say returns on Treasuries will remain suppressed for years to come, ending the three-decade bull market in bonds. The rate on 10-year notes is less than half the 6.4% aggregate earnings yield of stocks in the Standard & Poor’s 500 Index and the gap is about double the average of 1.9 points since 2000.
Evidence of a U.S. economic recovery has dimmed the allure of government assets and may trigger further bond funds outflows, said Donald Ellenberger, who oversees about $10 billion as co-head of government and mortgage-backed securities at Federated Investors in Pittsburgh. U.S. consumer confidence climbed in June to the highest level in more than five years. Home prices have increased 12% since April 2012, according to the S&P/Case-Schiller Composite Index.
“The biggest risk to the bond market right now is continued outflows from mutual funds and ETFs,” Ellenberger said in a phone interview on July 5. “The outflow in June might only be the tip of the iceberg.”
Ellenberger said if retail investors continue to sell bonds to cut duration, a move aimed at reducing an impact of higher interest rates on bond investments, yields will climb further.
Bulls say Treasuries will remain attractive because they form the world’s most liquid pool of securities. The $10.5 trillion market compares with $1.8 trillion in Germany and Britain. Primary dealers traded $504 billion of U.S. government debt the week ended June 13, according to Fed data. Daily turnover of French government bonds was around $18 billion.
China’s holdings of U.S. government securities rose 157% since the start of 2008 to $1.3 trillion, or 22% of total U.S. government securities owned by foreigners, according to the most recent data compiled by Bloomberg. Japan’s $1.1 trillion was up 88% from five years ago.
Analysts forecast Treasuries will rally from current levels. Ten-year note yields will drop to 2.41% by year- end, according to the median forecast of 78 strategists surveyed by Bloomberg.
The selloff lifted the Treasuries term premium, a model that calculates the risk of longer-duration debt. The measure, which includes expectations for interest rates, growth and inflation, climbed to 0.46% on July 5, the most since July 2011, according to asset manager Columbia Management Investment Advisers LLC. That compares with an all-time low of negative 0.64% a year ago. A negative reading suggests investors are willing to accept yields below what’s considered fair value.
Higher yields could backfire and damp economic growth, according to Deutsche Bank AG. HSBC Holdings Plc, Europe’s biggest bank and the parent of HSBC Private Bank, predicts that 10-year yields approaching 3% will slow the U.S. by hurting the housing market. That, and sluggish emerging economies, will underpin demand for haven assets, the bank said.
“This is a selloff that is more likely to preclude, rather than reflect recovery,” Deutsche Bank analysts including Dominic Konstam, the head of rates research, wrote in a note dated June 28. “Market turbulence could short circuit any virtuous circle dynamic that would ultimately lower unemployment and raise wages.”
Developing nations expanded 4% in the first quarter, the least since 2009 and down from the average 6.4% over the past decade, according to Capital Economics. Investors pulled money from emerging markets at the fastest pace in two years as cooling growth and the prospect of less U.S. stimulus sapped demand for financial assets from India to Brazil.
“We had periods of selloff which involved both Treasuries and higher-risk assets,” said Eric Brard, the global head of fixed income at Amundi in Paris. “It’s likely that increased risk in some market segments such as emerging-market debt will drive demand for Treasuries. We tend to be more interested in safe-haven assets than higher yields in that environment.”