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 Portfolio managers at large U.S. bond funds are, however, a bit
optimistic. They say the most violent adjustment in the bond market
has already happened, even though bond yields should rise a little
more in 2014 as the Federal Reserve reduces its massive stimulus
program.
Some analysts have long foreseen a protracted rise in yields after
nearly 30 years of steadily falling rates. But the consensus among
managers is that benchmark 10-year Treasury yields should peak
around 3.5 percent this year, up from 3 percent now and remain
otherwise in a tight range. A 50-basis point rise would pale against
the 125 basis-point rise in yields in 2013.
"We don't expect another aggressive bond sell-off. I think even with
the Fed tapering, policy accommodation will remain pretty high in
2014," said Jennifer Vail, head of fixed-income research at U.S.
Bank Wealth Management in Portland, Oregon.
Another surge in yields would mean more misery for bond investors,
including Bill Gross, who runs the world's biggest bond fund, the
Pimco Total Return Fund <PTTRX.O>. That fund suffered its first
annual loss since 1999, a negative return of nearly 2 percent.
But if the rise in yields is moderate and orderly, Gross and other
investors who are bullish on Treasuries would have plenty of time to
adjust their portfolios to reduce losses and take on bets in other
bond sectors.
Fund flows into Treasuries in 2013 were slower than any other year
since 2000. Pension funds, insurance companies, college endowments
and foreign investors could find greater appeal in Treasuries as
yields edge higher in coming months, but retail investors might
still shy away from bond funds, particularly given the buoyant
outlook for equities.
"Any zig-zag in rates will have retail investors very nervous," said
Quincy Krosby, market strategist at Prudential Financial in Newark,
New Jersey, which oversees $1 trillion in assets.
The yield on 10-year Treasury notes was 2.99 percent on Friday,
roughly a two-and-a-half-year high and nearly double what it was a
year ago. Increases in yields accelerated in May, after Fed Chairman
Ben Bernanke suggested before a congressional panel that the Fed
might consider shrinking its quantitative easing before year-end.
Recent data has supported the view of a somewhat slow-growing U.S.
economy, which will likely keep the Fed tapering gradually and
cautious about raising interest rates.
"What the market is adjusting to is a little faster growth and less
Fed buying. It could be another year of negative returns," said
Gemma Wright-Casparius, portfolio manager at Vanguard, the top U.S.
mutual fund company.
The 10-year yield has stabilized above 3 percent as investors await
the payrolls report for December to determine if the economy is
strong enough for Fed to quicken its stimulus reduction and possibly
raise rates before late 2015.
On Friday, Richmond Fed President Jeffrey Lacker said if the economy
strengthens more than expected this year, he could see the Fed
increasing rates in later 2014.
With blue chip stocks powering into record territory, investors have
been moving away from bond funds since June. Still, bond funds were
able to report $29 billion in inflows in 2013, although they were
the weakest since 2000, according to Lipper, a unit of Thomson
Reuters.
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In fresh quarterly forecasts released last month, the Fed's outlook
on growth of gross domestic product was in a range of 2.8 percent to
3.2 percent in 2014, a tad stronger than what Wall Street expects.
"There's a fair amount of economic optimism priced into these
yields," said Bill Irving, a Merrimack, New Hampshire portfolio
manager for Fidelity Investments, the No. 2 U.S. mutual fund
company. "I don't see the 10-year yield going much higher from here.
We have to see more surprisingly strong data."
The threat to this view of a moderate yield rise would come if
growth, perhaps driven by the U.S. energy production boom and the
impact of higher home and stock prices on consumer spending, were to
rise to 3.5 percent to 4.0 percent. That would in turn put pressure
on the Fed to pull back on its bond buying more quickly and lead to
concerns that the Fed would raise short-term interest rates sooner
than the late 2015 currently expected. All that could force bond
yields significantly higher than 3.5 percent.
Since the Fed began purchasing Treasuries and mortgage-backed
securities, its balance sheet has ballooned by more than $1 trillion
to near $4 trillion since late 2012.
On December 18, Fed policymakers said the U.S. central bank will
purchase $75 billion in bonds in January, $10 billion less than the
monthly pace at which it had been buying.
BOND BEARS COMETH?
A lousy year for Treasuries is rare. Even including a dismal 2013,
the Treasuries market has posted annual losses only four times since
1973, according to Barclays, and has never experienced back-to-back
losing years.
In 2013, Treasuries suffered a 2.75 percent loss, while the broader
U.S. bond market declined 2.02 percent, the biggest annual drop
since 1994, according to indexes that Barclays compiles.
The biggest yearly rise in benchmark Treasuries yields in four years
disrupted the housing market this past summer, but it has proven to
be only a hiccup for the economy.
U.S. growth had recorded its best three months in nearly two years
this autumn, while Wall Street booked its biggest annual gain in
more than 15 years.
(Reporting by Richard Leong)
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