U.S TREASURYS CARRY WEIGHT OF THE WORLD / THE WALL STREET JOURNAL

Heard on the Street

U.S. Treasurys Carry Weight of the World

Yields Ride a Roller Coaster, and There Could Be More Dips Ahead

By Richard Barley                  

 

Feb. 12, 2015 2:14 p.m. ET

IMF chief Christine Lagarde, first row third from left, speaks with two Greek officials during the G20 meeting on Tuesday. Photo: European Pressphoto Agency


Bond markets are the heavyweight bruisers of the financial world: big, powerful and packing a hefty economic punch. But they are also surprisingly nimble and throw unexpected jabs.

Just look at the U.S. Treasury market this year. January saw another big rally in prices, which dragged the yield on the 10-year note down half a percentage point to 1.65%. Prices and yields move in the opposite direction.

But February has seen a big reversal: The yield is back dancing around 2%.

Among longer-dated bonds, in which swings in yields translate into big price moves, holders of debt maturing in 25 years or more who were up 9.6% by the end of January alone have seen year-to-date returns crumble to 3.6%, according to Barclays indexes. Returns include both price moves and interest payments.

That is still better than year-to-date returns for U.S. stocks. The S&P 500 has registered a total return this year of only about 1.2%. And it is far too early to declare that the bond bears, who have long been predicting higher U.S. yields, are finally right.

The Treasury market is still subject to forces that are pulling in opposite directions. And the tug of superlow, if not negative, global yields could pull Treasury yields lower.

Granted, the domestic U.S. picture argues for the higher yields normally associated with economic expansions. Gross domestic product has been expanding at just under 4% a year on average in nominal terms since 2010. The labor market is performing strongly; the U.S. added 3.1 million jobs in 2014 and over one million in the past three months.

Lower prices at the gasoline pump should add a tailwind for consumers. Despite weak headline inflation, the Federal Reserve looks to be on its way to lifting short-term interest rates later this year. In the face of all that, such low U.S. debt yields look incongruous.

No fixed-income market is an island unto itself, though, not even one as big as the Treasury market. And trouble lurks beyond U.S. borders.

The eurozone is once again grappling with Greece, and Wednesday’s meeting of eurozone finance ministers failed to agree to even a bland statement on progress. Emerging-market economies are no longer the bright hope they once were. China may be exporting lower inflation to the rest of the world as it tries to ramp up exports to offset slowing growth at home.

And a global currency war is under way. The Ukraine cease-fire deal is somewhat positive, but others have come and gone before, and the confrontation between Russia and the West will likely persist.

Most powerfully, yields elsewhere in global bond markets are far lower than those in the U.S.

They are even negative in big chunks of Europe. While the Fed may be preparing to raise rates, other central banks continue to row in the opposite direction. Sweden on Thursday was the latest, as its central bank cut interest rates into negative territory and announced its own bond-buying program.

Given that fixed-income investors exist in a world of relative returns, this will have a strong gravitational pull on U.S. yields.   

                                                    

Note the gap between 10-year U.S. and German yields. Currently, this is at nearly 1.7 percentage points. That is its highest level since the introduction of the euro in 1999.

That makes U.S. yields look attractive to foreign investors, particularly because the European Central Bank is about to start buying eurozone bonds, a move that is likely to depress those yields even further. The chance that investors buying Treasurys might also benefit from a stronger dollar is the cherry on the cake.

The domestic side of this battle appears to have had the upper hand in February. But the international picture could return to focus; the U.S. bond market always plays a haven role.

Doubts linger over the Fed’s path, too.

In a normal world, the argument for higher yields would be hard to counter. But the world remains far from normal. Developments outside the U.S. could again knock bond bears to the mat.