Saturday 24 February 2018

Analysis: Bond bears smell blood, others claw for buying opportunity

Traders work on the floor of the New York Stock Exchange (NYSE)
Traders work on the floor of the New York Stock Exchange (NYSE)

David Randall

Some of the biggest US investors believe the bond market has slipped into a bear phase. Others believe it has turned into one of the best buying opportunities in years.

Pimco, one of the world's largest bond fund managers, and widely followed Guggenheim Partners are among the investors who say benchmark 10-year Treasuries yielding 3pc - now within reach - are too hard to resist.

Other players, such as Wall Street bond king Jeffrey Gundlach, see a lot more selling pressure to come.

"Valuations are beginning to look more interesting," said Dan Ivascyn, group chief investment officer at Newport Beach, California-based Pacific Investment Management Co, known as Pimco, which oversees more than $1.75 trillion in assets.

"We can see some further weakness in rates, especially the first half of year. But we still see limited upside for yields from here."

Scott Minerd, global chief investment officer at Guggenheim, who helps oversee more than $260bn in assets, agreed. "We’re waiting for 3pc," he said. "We definitely will add there. No one will perfectly time the bottom."

Investors have already pounced on bonds even below the 3pc level.

On Monday, investors rushed into Treasuries as the S&P 500 and Dow Jones Industrial Average nosedived more than 4pc - reversing a move on Friday when a spike in bond yields, which move inversely to prices, triggered an equity rout.

The yield on the benchmark 10-year Treasury ended the session at 2.71pc, down dramatically from 2.852pc on Friday, the highest level since January 2014.

Some investors doubt the flight to safety into Treasuries will be long-lasting: Inflationary fears, strong economic data and an announcement of bigger Treasury auctions have and will continue to drive yields higher, they say.

Indeed, the 10-year Treasury yield hit a four-year high on Friday after the latest monthly US jobs report showed solid wage gains, effectively confirming an expected rate increase at the Federal Reserve’s next meeting, in March.

Investors have been bracing for such moves in Treasuries.

Yields in the $14 trillion market for US government debt touched record lows in 2016, driven by years of aggressive central bank intervention in the wake of the 2008-2009 financial crisis to keep interest rates low to stimulate the economy.

Now, as the Federal Reserve is expected to raise interest rates three times this year and as some economists predict that the European Central Bank will start to raise rates later this year, investors are grappling with the effects of prolonged rising rates for the first time in nearly 10 years.

With inflationary pressures and massive budget deficits having become the topic du jour this year, the bond-market "vigilantes" term has made its way back onto trading floors.

The term "bond vigilantes" was coined by Ed Yardeni, the longtime Wall Street strategist now president at his namesake research firm. Yardeni was describing the demand by investors in the 1980s for high yields to compensate for the perceived risks of inflation and budget deficits.

All told, the jump in Treasury yields has yet to make its way into the broader economy in the form of higher borrowing costs, yet it will likely start to dampen the housing and auto markets as consumer loans become more expensive, said Gary Cloud, a portfolio manager of the Hennessy Equity and Income Fund. That, in turn, will make it less likely that the Fed raises rates more than three times this year, he said.

"We're not haters of the bond market here at all. Treasuries look very cheap compared to other income classes" such as high-yield credit or mortgage debt, he said.

Technical Signs

Not all prominent bond fund managers are buying in. Billionaires Bill Gross and Ray Dalio believe the bond market is at the beginning stages of a bear market.

Gundlach, the chief executive of DoubleLine Capital, told Reuters on Saturday that it is "hard to love bonds at even 3pc when GDPNow for Q1 2018 is suggesting annualized nominal GDP growth above 7pc," referring to a new indicator of economic growth from the Atlanta Fed.

Meanwhile, benchmark 10-year note yields have broken above a long-term downtrend in effect since the 1980s, which some technical strategists see as a bearish indicator going forward. If yields continue to rise, it could further confirm the breakdown of the more-than 30-year bull run.

Paul Ciana, a technical strategist at Bank of America Merrill Lynch, sees the next major support level for 10-year notes at around 2.95pc, the 150-month simple moving average, which they last touched in 2007. A break above that could lead the yields to next test 3.28pc, the 200-month simple moving average, which has not been reached since 1989.

Ciana sees a monthly close above 3.03pc as technically confirming a so-called double bottom, which is when yields retest a previous low and which can signal a trend reversal. A close above that level could send the benchmark yields "well into the mid-4pc area," Ciana said in a report on Monday.

Richard Bernstein, chief executive of Richard Bernstein Advisors, said he would be a buyer when the yield curve inverts.

The yield curve - the plot of all of the yields on Treasury securities of maturities from four weeks to 30 years - is used as a signal of economic health of the economy. An inverted curve, when short-term yields are higher than long-term ones, has served as a classic precursor of economic recession.

"If you're a bond investor you'll lose much more sleep than equities," said Bernstein.

Reuters

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