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 Conflicts in Ukraine and the Middle East, and record low bond yields
in Europe, have unleashed a stampede into Treasuries, knocking
benchmark 10-year yields to 2.30 percent, a 14-month low at one
stage on Friday. They ended the week at 2.34 percent.
The U.S. bond rally, which accelerated on Friday after Ukraine
claimed its artillery destroyed part of a Russian armored column
that entered its territory, has shown earlier market calls from some
leading bond investors, such as DoubleLine's Jeffrey Gundlach, to be
on the money.
"We are in a market environment now that is largely beyond
fundamentals," said Chris Orndorff, portfolio manager at Western
Asset Management in Pasadena, California, a leading U.S. bond
manager that has about $470 billion in assets. "The falling yield
levels are a reaction to panic, as U.S. Treasuries continue to play
the role that they have always played, the favorite asset in a
flight-to-quality environment."
U.S.-based funds that invest primarily in Treasuries have attracted
inflows for four straight weeks, accumulating more than $4.5 billion
of new investor cash in that run, according to Lipper, a unit of
Thomson Reuters. The four-week moving average of flows shows
investors moving into this sector at the fastest pace in nearly six
months.
Meanwhile, more speculative investors such as hedge funds, have
reversed their recent short positions in 10-year Treasury futures
and options. The latest week's Commitments of Traders data from the
Commodity Futures Trading Commission showed speculators were net
long by about $374 million after being net short by $616 million the
week before.
The latest bull run in bonds has defied expectations of those
traders and investors who had bet on U.S. interest rates rising this
year as the U.S. jobs picture improved and the U.S. Federal Reserve
paved the way to tighten policy in 2015.
Bond yields could decline further if, as expected, Fed Chair Janet
Yellen reiterates her concerns about underlying weakness in the
labor market in her speech next week at a global central bankers
conference in Jackson Hole, Wyoming.
"She is going to remind us why they would maintain a dovish policy
stand," Jeffrey Rosenberg, chief investment strategist for fixed
income at New York-based BlackRock, the world's biggest asset
manager with $4.3 trillion in assets.
Bond analysts and managers interviewed by Reuters on Friday said the
10-year yield could fall another 10-15 basis points. They didn't
rule out it reaching the 2 percent level in the current rally.
Still, they warned that if global political tensions ease, the
safe-haven demand for U.S. bonds will subside. Then, the 10-year
yield could snap back to 2.60-2.70 percent.
ROCK-BOTTOM EUROPEAN YIELDS
Foreign demand for U.S. Treasuries has also grown in recent weeks
because the yields on German and other European government bonds
continue to fall.
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The benchmark 10-year U.S. Treasuries yield has been running more
than 1.30 percentage points above the yield on 10-year German Bunds
since the beginning of July. This premium is the biggest since June
1999, which was before the euro was introduced.
Some big bond investors like Pimco's Bill Gross, who manages the
world's biggest bond fund with $223 billion in assets, see
Treasuries gains tied closely to the movement in Bunds. That's
because the consistently wide spread between the two makes it an
attractive carry trade for European-based investors to sell Bunds
and buy Treasuries. With the euro declining, investors would also
get a positive currency benefit.
This week, data showing anemic second-quarter growth across the euro
zone, suggesting the 18-nation block is close to deflationary
conditions. The European Central Bank is expected to fight
aggressively to prevent deflation from taking root by providing more
easy money, which in turn could see European bond yields fall
further.
"European government bond pricing is reaching an inflection point,
which will force the ECB to act,” said Larry Jeddeloh, chief
financial officer of the TIS Group, which produces the Market
Intelligence Report.
This week, the German 2-year yield fell into negative territory
while its 10-year yield dropped below 1 percent for the first time
ever. Italian and Spanish yields fell to record lows in step with
their German counterparts.
"This pulls global allocation into the United States," said
BlackRock's Rosenberg.
He said that Asian investors dealing with a stuttering Japanese
economy and fears of slower growth in China have been shifting more
money into U.S. debt.
The yield on 10-year Japanese government bonds ended Friday at 0.51
percent, 1.83 percentage points below the 10-year U.S. yield.
(Reporting by Richard Leong; Editing by Dan Burns and Martin Howell)
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