(The opinions expressed here are those of the author, a columnist for Reuters.)
By Jamie McGeever
LONDON, Aug 7 (Reuters) - The most powerful commercial banker in the world thinks the 10-year U.S. Treasury yield should be 4 percent and headed for 5 pct, even though it’s barely able to break above 3 pct.
“I think rates should be 4 percent today,” JP Morgan chief executive Jamie Dimon said at the weekend. “You better be prepared to deal with rates 5 percent or higher - it’s a higher probability than most people think,” Bloomberg News reported.
Dimon’s call is a long way from becoming reality. Whenever 3 percent looms, waves of buying from a range of investors push the world’s benchmark, risk-free bond yield right back down again.
It’s tried to break above 3 pct four times since April, the most recent being last week. The longest successful stretch was May 14-23 when it reached a seven-year high of 3.11 pct before falling sharply.
The length of time it has spent above 3 pct on the other three occasions can be measured in hours. Almost as soon as the threshold is reached, the yield quickly reverses and the curve flattens closer to outright inversion.
That the 10-year U.S. yield is not higher than 3 pct is one of the bigger market surprises of the year. The economy is humming along nicely, the Fed is raising rates and reducing its balance sheet, government borrowing and debt issuance are rising and speculators have built up a record short position.
Add to that GDP growth currently running at a 4.1 percent clip, unemployment below 4 percent and inflation close to the Fed’s 2 percent target, and one might expect 10-year borrowing costs to be higher than 2.95 percent.
But in a world of ultra-low yields, ageing populations and falling trend growth, a 3 percent return for investing in probably the world’s safest and most liquid financial asset is too good for too many to turn down.
In relative terms, it’s a no-brainer. Emerging market sovereign bonds yield barely more than 300 basis points over Treasuries, which isn’t much considering the added risk the buyer is taking on holding them over U.S. debt. Look at Turkey and Argentina.
Meanwhile, U.S. Treasuries yield far more than comparable highly rated, sovereign debt. The 10-year German Bund yields 0.4 percent, the UK gilt 1.3 percent and the benchmark Japanese Government bond 0.10 percent.
At both ends of the risk spectrum, there’s a natural pull for fixed income investors to lock in a risk-free rate of 3 percent.
Analysts at Morgan Stanley think longer-dated yields reached their highs for the year in the first half. They recommend that investors buy 10-year Treasuries. Analysts at Citi note that longer-term real yields are at the “upper end of multi-year ranges” and if history is an accurate guide, should fall.
Even those with a more bullish view of the economy and risk assets reckon yields may not rise much above 3 percent. Blackrock, the world’s biggest asset manager with more than $6 trillion under management, says “insatiable” global demand for yield and safety will continue to anchor longer-dated U.S. bond yields.
A major source of that demand comes from pension funds, whose managers seek safe and highly liquid assets which them to better match their assets and liabilities. Pension funds are also big buyers of corporate bonds.
U.S. corporate pensions have some $1.55 trillion in assets. They could be poised to shift a portion of that into fixed income because gains on Wall Street have helped narrow their funding gap, giving fund managers more leeway to de-risk.
U.S. companies are also taking advantage of tax reform legislation to put more into their pension plans. Taken together, that’s potentially billions more going into longer-dated corporate bonds and Treasuries, helping to cap yields.
But the 3 percent level may be little more than a case of “round number-itis” beyond being a big number around which investors and traders hedge and put buy and sell orders.
“Beyond being a psychological and near term trading level, the 3 percent mark does not hold any other significance,” says Koray Yesildag, an asset allocation specialist at Aon, pegging “fair value” for U.S. Treasuries at anywhere between 3 and 4 percent.
Reporting by Jamie McGeever