Tags: federal reserve | treasury bonds | yields | economy

Yield Ahead: Fed's QE Exit Will Result in New Bond Dynamic

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Tuesday, 29 Jul 2014 11:25 AM Current | Bio | Archive


While “bad” geopolitical news continues unabated around the globe, it’s really interesting to see how the whole situation hasn’t curbed investment advisors’ overall optimism.

This obvious demonstration of complacency isn’t the case with all investors, as Swiss based bank UBS AG (which is the world’s top wealth manager, according to London consultancy Scorpio Partnership) said its wealthy clients show low levels of confidence and keep close to 30 percent of their assets in cash because of geopolitical global risks.

Meanwhile, NYSE margin debt data for June showed the second-highest level ever at $464.3 billion (February printed $465.7 billion, which was an all-time high), which confirms widespread bullishness among investors/speculators. But that also means if we should have a sudden run for the exits, we’ll have traffic jams of historical proportions. I’m not saying that will happen tomorrow, but it could and probably will — one day.

The big question remains when and why Treasury yields will finally start rising. I have no doubt that because tapering is coming to an end, yields will start creeping higher. But we could see new lows if something “bad” should happen on the geopolitical front because U.S. Treasurys remain the top haven in the world.

Editor’s Note: New Warning - Stocks on Verge of Major Collapse

Since the Federal Reserve announced its third round of quantitative easing (QE3), whereby it would purchase $40 billion of bonds a month, the Fed became the largest Treasury buyer on the planet, it resulted with less than $300 billion of notes (with 2, 3, 5 and 10-year terms) and bonds (longer than 10-year) remaining available to other investors.

I don’t think it’s such a big surprise that this wasn’t sufficient to satisfy foreign demand, which created a permanent bid for longer Treasurys with higher prices and lower yields.

The U.S. budget deficit is further shrinking to an estimated $500 million this year while the Fed apparently has changed its purchase preferences over the past few initiatives, focusing on Treasurys of the longer end of the curve, which has contributed to the relative scarcity of these categories of Treasurys.

It is estimated the Fed now owns more than half of the duration weighted outstanding Treasurys.

That means that during the coming year or so, the Fed — which has been a “half a trillion” government buyer — will disappear from the market.

Foreign demand for Treasurys is extremely difficult to estimate, but we have seen a slowdown on foreign buying, which has been one of the reasons why the markets have been unable to challenge the 10-year 2.4 percent low of May 29.

Meanwhile, we have seen the Chinese renminbi “strengthening” slowly, which could indicate Chinese are slowing down their interventions for weakening their currency, which in turn has created demand for U.S. Treasurys for their dollar holdings.

Elsewhere, the U.S. deficit continues on its downward path while the Congressional Budget Office (CBO) from its side expects for the coming years a deficit in the range of 3 percent of GDP while at the same time it is expected we could experience a 3 percent GDP growth rate.

At the same time, Treasury issuance should be in the range of $500 billion to $550 billion into 2017, which will translate in a 60 percent supply increase when we compare that to the net available amounts of Treasurys in 2013 and 2014.

We’ll see progressively lower prices for longer-term Treasurys, like the 10-year, that will move yields up to about the 3 percent zone and that should be reached within achievable within the next 12 months and notwithstanding the Fed’s message will likely remain constant till more or less next year.

The combination of substantially less Fed buying, more supply and a slowly but nevertheless an improving economy will by themselves alone and without the Fed raising rates, push yields on longer term U.S. Treasurys slowly higher, which will be in sharp contrast with most of the rest of the world.

Long-term investors when allocating funds should keep in mind normalization at the Fed could, and probably will, disturb other economic blocs, like most of the emerging economies while Europe, most probably, will remain in the doldrums for a long time to come. Sanctions won’t help EU economies.

We are at the dawn of a new divergence developing in Treasury yields among the most important economies of the world and of which I expect, of the most important economies, only the United States and to a lesser extend China showing a tightening bias before the year is over.

Editor’s Note: New Warning - Stocks on Verge of Major Collapse

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HansParisis
We are at the dawn of a new divergence developing in Treasury yields among the most important economies of the world and of which I expect, of the most important economies, only the United States and to a lesser extend China showing a tightening bias before the year is over.
federal reserve, treasury bonds, yields, economy
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2014-25-29
Tuesday, 29 Jul 2014 11:25 AM
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