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To Some Investors, 10-Year Treasury Note Isn’t What It Was (#GotBitcoin?)

It was once every investor’s touchstone. Now, the 10-year yield ‘has apparently lost any heartbeat.’ To Some Investors, 10-Year Treasury Note Isn’t What It Was (#GotBitcoin?)

For years, the 10-year U.S. Treasury note has been every investor’s touchstone. Now some people are saying they can’t trust its signals the way they once did.

Related:

Re-Hypothecation of U.S. Treasury Notes And Systemic Failure

 

The yield on the benchmark U.S. government security, long a key economic barometer for financial markets around the world, barely budged in response to Friday’s better-than-expected jobs report. It now enters the week parked near record lows around 0.55%, with investors preparing to parse stimulus talks, data on inflation and new tensions between the U.S. and China.

That is near the bottom end of the narrow range in which the yield has stalled for months, frustrating those who have long expected it to rise when investors are feeling optimistic about growth and inflation and fall when their outlook dims.

The yield “has apparently lost any heartbeat,” wrote Peter Boockvar, chief investment officer at Bleakley Advisory Group, after the report.

U.S. government bonds have rarely been in greater demand than during this year’s pandemic-fueled market mayhem. Asset managers scooped up Treasurys to cushion portfolios when stock markets unraveled in March until banks were hamstrung by investors’ simultaneous flight to cash and the market temporarily dried up.

Then the Federal Reserve intervened, dropping interest rates to zero and buying billions of dollars worth of Treasurys weekly to boost lending and stave off economic calamity. Now the central bank is preparing to abandon its three-decade-old practice of pre-emptively lifting rates to tamp down inflation, allowing for periods in which prices rise at a faster pace than its 2% target.

The combination has depressed the 10-year yield, leaving it stuck even as stocks rebound and measures of investors’ inflation expectations rise. That leaves some contending that the 10-year note is losing its qualities as a window on the economy, a hedge against nosediving stocks or a producer of steady, low-risk investment income.

“Government bonds have less room to rally if things go wonky,” said Elga Bartsch, head of markets and economic research at the BlackRock Institute, the investment-analysis division of the world’s largest asset manager.

Pension funds, endowments and people saving for retirement have long assumed that when times got tough, they could park their cash in Treasurys, a risk-free asset that still produced returns. In 1987, when Black Monday sent stocks tumbling, the 10-year note yielded nearly 10%. When Lehman Brothers declared bankruptcy in September 2008, the yield was around 3.5%. Now it has closed below 0.6% for two consecutive weeks.

Wall Street economists hotly debate the reasons behind the decadeslong decline, citing factors including central-banks policy, low growth and inflation and demographic shifts. Market-based measures of inflation expectations suggest even after the economy recovers from the pandemic shutdowns, investors anticipate a return to slow growth and low inflation.

The stability hasn’t quieted some longstanding worries. Some observers fear trade tensions with China could spur officials to pare the country’s roughly $1.8 trillion of Treasurys, though many deem that unlikely because that would hurt the value of China’s own holdings, including extensive stores of dollar-denominated stocks and corporate debt.

And while the Fed believes the pandemic and related job losses are disinflationary, others see new strains from the trillions in government borrowing aimed at limiting the economic damage. That could power a pickup in inflation, which tends to hurt the value of bonds by eroding the purchasing of their fixed payments.

For years, the 10-year U.S. Treasury note has been every investor’s touchstone. Now some people are saying they can’t trust its signals the way they once did.

The yield on the benchmark U.S. government security, long a key economic barometer for financial markets around the world, barely budged in response to Friday’s better-than-expected jobs report. It now enters the week parked near record lows around 0.55%, with investors preparing to parse stimulus talks, data on inflation and new tensions between the U.S. and China.

That is near the bottom end of the narrow range in which the yield has stalled for months, frustrating those who have long expected it to rise when investors are feeling optimistic about growth and inflation and fall when their outlook dims.

The yield “has apparently lost any heartbeat,” wrote Peter Boockvar, chief investment officer at Bleakley Advisory Group, after the report.

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U.S. government bonds have rarely been in greater demand than during this year’s pandemic-fueled market mayhem. Asset managers scooped up Treasurys to cushion portfolios when stock markets unraveled in March until banks were hamstrung by investors’ simultaneous flight to cash and the market temporarily dried up.

Then the Federal Reserve intervened, dropping interest rates to zero and buying billions of dollars worth of Treasurys weekly to boost lending and stave off economic calamity. Now the central bank is preparing to abandon its three-decade-old practice of pre-emptively lifting rates to tamp down inflation, allowing for periods in which prices rise at a faster pace than its 2% target.

The combination has depressed the 10-year yield, leaving it stuck even as stocks rebound and measures of investors’ inflation expectations rise. That leaves some contending that the 10-year note is losing its qualities as a window on the economy, a hedge against nosediving stocks or a producer of steady, low-risk investment income.

“Government bonds have less room to rally if things go wonky,” said Elga Bartsch, head of markets and economic research at the BlackRock Institute, the investment-analysis division of the world’s largest asset manager.

Pension funds, endowments and people saving for retirement have long assumed that when times got tough, they could park their cash in Treasurys, a risk-free asset that still produced returns. In 1987, when Black Monday sent stocks tumbling, the 10-year note yielded nearly 10%. When Lehman Brothers declared bankruptcy in September 2008, the yield was around 3.5%. Now it has closed below 0.6% for two consecutive weeks.

Wall Street economists hotly debate the reasons behind the decadeslong decline, citing factors including central-banks policy, low growth and inflation and demographic shifts. Market-based measures of inflation expectations suggest even after the economy recovers from the pandemic shutdowns, investors anticipate a return to slow growth and low inflation.

The stability hasn’t quieted some longstanding worries. Some observers fear trade tensions with China could spur officials to pare the country’s roughly $1.8 trillion of Treasurys, though many deem that unlikely because that would hurt the value of China’s own holdings, including extensive stores of dollar-denominated stocks and corporate debt.

And while the Fed believes the pandemic and related job losses are disinflationary, others see new strains from the trillions in government borrowing aimed at limiting the economic damage. That could power a pickup in inflation, which tends to hurt the value of bonds by eroding the purchasing of their fixed payments.

BlackRock Inc. said it is reducing the amount of sovereign bonds it typically purchases and is buying more Treasury inflation-protected securities, or TIPS, which compensate bondholders if inflation rises. TIPS yields have fallen sharply this year.

“You need more-diverse hedges than in the 1980s,” said Rick Rieder, chief investment officer of global fixed income at BlackRock. “And what you hold as assets has to be different. We haven’t ever seen this dynamic—where the willingness to functionally print money to get to the other side of a tough shock to the system is so big.”

As a hedge against stock declines, Mr. Rieder said the 10-year note earned a grade of “B- at best.” He is also holding gold to protect against inflation.

Ashok Bhatia, deputy chief investment officer for fixed income at Neuberger Berman, said TIPS are just a part of a diversified solution to compensate for low yields and that some asset managers are rotating into corporate bonds, asset-backed securities and agency mortgage-backed securities now that the Fed “is providing quasipermanent support.”

The Fed formally opened a $500 billion lending program in June to support issuance of new debt by large corporations, while also adding to purchases of existing debt. The move boosted the appeal of highly rated corporate debt, leaving investors buying more company bonds than usual because they offer higher yields and now come with an implied backstop from the Fed, said Chris Stanton, chief investment officer of Sunrise Capital Partners.

“You never would have replaced the 10-year with investment-grade corporate debt in the past,” said Mr. Stanton. “You bought sovereign debt because companies could default.”

Investment-grade corporate-bond yields are trading around all-time lows, according to Bloomberg Barclays data. Daily volumes in debt linked to the highest-rated companies surged 35% to $99.5 billion in the first half of 2020 compared with the same period a year earlier, according to JPMorgan Chase & Co. research analysts.

Some traders and analysts say the 10-year note is irreplaceable because it remains the world’s primary risk-free asset. To them, the safest corporate bond makes a poor substitute because even the strongest companies can go out of business. The U.S. government, on the other hand, can print its own money.

There also are structural reasons for the 10-year note to persist at the center of global finance. Hedge funds, for example, use it to fund a popular strategy known as the basis trade, which seeks to exploit pricing gaps between Treasurys and futures.

“It is a very unique instrument because you don’t have to worry about not getting your money back,” said Mr. Bhatia. “The minute you move to other investments, you break the barrier of a true risk-free asset.”

Updated: 2-28-2021

Bond-Market Tumult Puts ‘Lower For Longer’ In The Crosshairs

A recent wave of selling drove up the yield on the 10-year Treasury note, which helps set borrowing costs from corporate debt to mortgages, to its highest level since the pandemic began

February’s government-bond rout has rattled one of the foundations of the past year’s powerful stock-market rally: investor certainty that ultralow long-term interest rates are here to stay.

A wave of selling during the past two weeks drove the yield on the benchmark 10-year Treasury note, which helps set borrowing costs on everything from corporate debt to mortgages, to above 1.5%, its highest level since the pandemic began and up from 0.7% in October.

A series of Federal Reserve officials have said the climb is a healthy one, reflecting investors’ improving expectations for a vaccine- and stimulus-fueled economic recovery. Many portfolio managers say they believe rates are likely to flatten out in coming days as yields finally reach what they see as attractive levels.

Those views will get a fresh test this week, with Fed Chairman Jerome Powell scheduled to make a public appearance Thursday and the release of February’s jobs report Friday.

But there are signs, such as unusually soft demand for recent Treasury debt auctions, that selling may not be over and yields may have further to rise. Some traders warn that bond markets are signaling a powerful economic recovery that could upend the dynamics that have held borrowing costs low while powering stocks to records—potentially a recipe for more of the topsy-turvy trading seen over the past week, when the Dow industrials swung more than 1,000 points over three days.

“There is a view that recovering from a pandemic looks different than from a normal recession,” said Michael de Pass, global head of U.S. Treasury trading at Citadel Securities.

Traders said concerning dynamics were evident in a Treasury auction late last week. Demand for five- and seven-year Treasurys was weak Thursday heading into a $62 billion auction of seven-year notes and nearly evaporated in the minutes following the auction, which was one of the most poorly received that analysts could remember.

The seven-year note was sold at a 1.195% yield, or 0.043 percentage point higher than traders had expected—a record gap for a seven-year note auction, according to Jefferies LLC analysts. Primary dealers, large financial firms that can trade directly with the Fed and are required to bid at auctions, were left with about 40% of the new notes, about twice the recent average.

The tepid demand concerned investors because the government is expected to sell a huge amount of debt in coming months to pay for the stimulus efforts that undergird the recovery. Further poor auction results could fuel additional selling in bond markets and undermine the tone in other markets, such as those for stocks, investors said.

Analysts thought that an increased supply of Treasurys could weigh on the market heading into the year, but “it’s very different when you’re actually dealing with it,” said Blake Gwinn, head of U.S. rates strategy at NatWest Markets.

Some traders said recent moves have been exacerbated by the unwinding of popular trades that involve buying short-dated Treasurys and selling other assets against them. Many singled out one in particular: holders’ effort to protect their investments in mortgage bonds against the climb in yields, a practice known in industry parlance as convexity hedging.

The Fed’s rate cuts during the past year helped fuel a wave of home sales and refinancings, but the recent climb in yields drove mortgage rates to their highest level since November this past week, and applications have dropped. That forces banks and other holders, such as real-estate investment trusts, to sell Treasurys to offset losses in mortgage bonds that happen when consumers stop refinancing.

Moves in market-based measures of inflation are also prompting concerns. Rising prices dent the purchasing power of bonds’ fixed payments and could force the Fed to raise rates sooner than expected. While inflation has remained muted for years, usually below the Fed’s 2% target, some worry that the economic reopening and stimulus efforts by the Fed and Congress could spark an acceleration.

The five-year break-even rate—a measure of expected annual inflation over the next five years derived from the difference between the yields on five-year Treasurys and the equivalent Treasury inflation-protected securities—hit 2.4% in recent days, the highest since May 2011.

“The question is whether 2% inflation can be sustained once we reach it,” said Matthew Hornbach, global head of macro strategy at Morgan Stanley. He said the scale of U.S. fiscal stimulus means that inflation “has a very reasonable chance of getting to 2% and staying there.”

At the same time, the recent uptick in Treasury yields hasn’t only reflected increasing inflation expectations, as was essentially the case earlier in the year. Over the past two weeks, yields on Treasury inflation-protected securities—a proxy for so-called real yields—have also shot upward, with the 10-year TIPS yield rising from roughly minus 1% to minus 0.7%.

That move has caught investors’ attention because many credit deeply negative real yields with helping power stocks to records, pushing yield-seeking investors toward riskier assets. Real yields were around zero percent or higher from the middle of 2013 through the start of 2020, meaning they might have more room to rise even after their recent move.

The yield on the benchmark 10-year U.S. Treasury note settled at 1.459% Friday, down from 1.513% a day earlier but up from 1.344% at the end of the previous week.

For now, many investors are moving into assets that are less vulnerable to swings in rates. Stocks are less competitive with bonds when yields rise. Shares in some of the most popular technology stocks, including Amazon.com and Apple, have fallen from their highs in the past month.

Rick Rieder, chief investment officer of global fixed income at BlackRock Inc., said his team has been buying floating-rate loans rather than bonds to protect against rising interest rates and benefit from the economic recovery.

“We rotated a good deal of our high-yield bond exposure into loans,” said Mr. Rieder. “Real rates have been running at negative 1%. They are finally moving, but they still have a bit more to go, which will ultimately push interest rates higher than today’s levels.”

Updated: 3-31-2021

How Japanese Investors Accelerated The Treasury Selloff

Banks focused on booking profits by the Japanese fiscal year-end unloaded bonds in recent weeks.

The sharp rise in Treasury yields in recent weeks looked like a test of whether the Federal Reserve can keep interest rates low after the economy regains its footing.

Under the surface, other factors drove the selloff in U.S. government bonds, pushing prices down and yields up, according to investors and analysts. One factor was heavy selling by investors in Japan who were locking in investment returns for their year-end.

The yield on the 10-year Treasury rose from close to 1% at the end of January to an intraday peak of over 1.77% on Tuesday.

Banks and insurers in Japan put extra impetus into a wave of global selling in February, according to investors and analysts. It was prompted by efforts to finalize their investment returns for their financial year ending Wednesday.

Dai-ichi Life Insurance Co. , one of Japan’s major insurance firms, said it had been selling some U.S. Treasurys and reinvesting in sovereign and corporate bonds in other currencies. It wouldn’t give further details, but said it was working on investment plans for the new fiscal year.

Large Japanese investors have collectively made net sales of ¥2.815 trillion, equivalent to $25.5 billion, worth of foreign bonds since the start of February, according to Ministry of Finance data up to March 20, the most recent available.

It wasn’t only Japanese firms. Seoul’s Kyobo Life Insurance Co. Ltd. was also a seller of longer-dated U.S. Treasurys, according to Matt Lee, head of overseas investments at the company. “There’s a high chance that U.S. interest rates will continue to rise,” he said.

One sign that Asian investors led the selloff in Treasurys was the timing of the market moves, according to several investors. Some Treasury auctions struggled in late February. Analysts at that time spoke of a buyers’ strike among Asian investors causing a shortfall in demand.

Guneet Dhingra, head of U.S. rates strategy at Morgan Stanley in New York, tracked the differences in the timing of market moves. He found that during February, when the Treasury selloff accelerated, most of the upward move in yields came during Japanese trading hours.

In March, up until the recent Fed rate-setting meeting, the selling was more split between Tokyo and London trading hours. In recent days, buying during Asian hours has led yields back down from their peaks, Mr. Dhingra said.

The Japanese selling wasn’t driven by any fundamental concern or changes in investors’ views of Treasurys, Mr. Dhingra said. Instead, banks in particular were looking to offset bond losses against equity gains.

“The selling was driven by Japanese banks looking to smooth the volatility of their portfolio returns for the year-end,” he said.

The rise in yields caused by this selling affected the psychology and market views of other investors, who reacted and began selling more themselves. The pressure moved through the market in March, into London hours and then early New York trading.

Some of the biggest Japanese investors, such as the Government Pension Investment Fund, Japan Post Bank and the Norinchukin Bank, a large lender for Japanese farmers, haven’t disclosed recent Treasury holdings and declined to comment.

Foreign buyers are an important source of funding for the U.S., while Treasurys are a safe home for dollars for banks in Asia and countries elsewhere that have large export industries. The dollar is the main currency used in global trade.

Foreign investors’ share of the Treasury market has fallen in recent years as issuance has grown. At the end of 2013, foreign investors owned more than 43% of all Treasurys, according to data from the Securities Industry and Financial Markets Association, a trade body. Their share was less than 30% by the end of 2020.

Asian investors broadly are concerned by the extraordinary supply of Treasurys to be sold this year, according to David Beale, who covers emerging-market institutions globally for Deutsche Bank from Singapore. Deutsche Bank estimates that Treasurys outstanding could grow by $1.7 trillion this year.

International investors aren’t likely to be put off by the flood of planned issuance, said Gareth Colesmith, head of global rates at Insight Investment in the U.K. “I don’t think it’s about perception of the U.S. as a credit risk yet, although if this level of spending and debt growth persists, you will eventually see a ratings downgrade,” Mr. Colesmith said.

The good news for Treasury markets is that Japanese investors’ sales have slowed. They could also start buying again when the new financial year begins in April. It might not happen straight away, though the extra yield that U.S. Treasurys offer over Japanese government debt has grown.

Japanese investors are likely to be cautious while the market is volatile but would have to return eventually, according to Tsuyoshi Ueno, an economist at NLI Research Institute, a unit of Nippon Life Insurance Co.

“Additional returns from U.S. Treasurys and other foreign bonds are important sources of income for Japanese investors,” Mr. Ueno said. “They have no choice but to buy.”

Japanese investors can earn a 1.3% yield on 10-year Treasurys including currency-hedging costs, according to Mayank Mishra, macro strategist at Standard Chartered in Singapore. That is double the yield on a 30-year Japanese government bond.

Asian investors, particularly those in Japan, would be drawn back to Treasurys because yields on other safe debt are so low, according to Gary Smith, managing director at Sovereign Focus, which provides research and advice to central banks and sovereign-wealth funds.

“Japanese insurers or Asian central banks won’t look at recent performance and think: ‘We’ll buy German bunds instead,’” he said. “Negative yields are a big problem for central banks as owners.”

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