U.S. Government Bonds Pay More Than Debt From Other Developed Nations
20 May 2018 - 10:29PM
Dow Jones News
By Daniel Kruger
U.S. government bonds are paying more than debt from other
developed countries for the first time in almost two decades, a new
sign of investors' struggle to reconcile expectations for faster
U.S. growth with concerns about the impact of deficits and
inflation.
The yield on the benchmark 10-year Treasury note, a key
barometer for borrowing costs for consumers and companies, last
week topped 3.1%, its highest close in almost seven years. It's a
climb that's rippling through markets, buffeting stocks and helping
fuel a surprise rally in the dollar as higher rates attract
yield-seeking investors to the currency.
Analysts said the rise in yields in part reflects optimism about
the U.S. economy and expectations for a pickup in inflation, which
threatens the value of government bonds by eroding the purchasing
power of their fixed payments. A market-based measure of
expectations for annual inflation over the next 10 years, known as
the break-even rate, recently reached its highest levels since
2014.
The climb also shows the impact of the recent tax cut package
and a surge in government spending. Those have boosted short-term
growth expectations while increasing borrowing and the supply of
Treasury bonds, which can hurt bond prices. That comes as the Fed
has raised interest rates in recent years and begun paring bond
holdings accumulated during the financial crisis, unwinding
stimulus policies like those that continue to keep rates low in
many other countries.
"The U.S. has the highest rates of everyone in the G-10 and it
looks like the rate differential will continue to widen," said
Chris Gaffney, president of EverBank World Markets. "The U.S. seems
to be going it alone in this rising interest-rate path."
The 10-year yield's surge this year has pushed it above yields
on bonds from seven major developed countries for the first time
since June 2000, according to an analysis by Bianco Research. It
recently exceeded the yield on 10-year debt from a record number of
countries, according to Deutsche Bank Research, and surpassed the
10-year German bund yield by the most in almost three decades.
At the same time, economic data throughout much of the world has
failed to meet expectations, eroding support for bets that the
euro, yen and other currencies would rise versus the dollar. While
investors speculate about the Fed increasing its pace of monetary
tightening, they have also reduced their expectations for tighter
monetary policies in Australia, Canada, the U.K., Japan, the
euro-zone and other economies.
Higher Treasury yields are pushing investors back to the dollar,
after they crowded into bets that the euro would rise versus the
U.S. currency. As economic data has weakened in Europe, pushing
yields down even as monetary policy remains accommodative, signs of
employment and inflation growth U.S. have persisted, lifting
Treasury yields higher. That shift has squeezed some investors,
leading many to exit the trade.
Investors say they are also looking at the yield differential
because the gap has made it increasingly expensive for money
managers in Europe and Asia to buy U.S. government and corporate
bonds. Those investors are increasingly looking instead to buy debt
in Europe, where hedging costs are not a problem. This dynamic
could make borrowing more expensive for U.S. consumers and
businesses, and act as a check on growth.
Yields have surged along with bets that the Fed will speed up
its pace of interest increases, adding to the three that officials
forecast at their December and March meetings. That has raised
concerns that policy makers, in their zeal to cool inflation, may
prematurely tip the economy into recession.
Fed officials raised interest rates in March and penciled in two
more increases this year. Fed funds futures, used by investors to
bet on central bank policy, late Friday showed a 50% probability
that officials raise rates four times. That contrasts with the
situation in Europe where policy makers have yet to commit to
ending bond purchases this year, and the time table for raising
interest rates from their current level of minus-0.40% remains
uncertain.
The expectations for further rate rises has driven up the yield
on two-year Treasurys, which tends to move along with the direction
of Fed policy. That's narrowed the gap with longer-term rates,
known as the yield curve. The curve, which many investors use as a
signal of economic health, has been flattening lately, as
expectations for longer-term growth and inflation remain tepid.
Many investors are concerned the two-year yield could eventually
exceed the 10-year yield, a phenomenon known as an inverted yield
curve which has preceded every U.S. recession since at least
1975.
A Wall Street Journal survey of economists shows 59% of those
surveyed expect the economy to enter a recession in 2020, while 22%
foresee a contraction in 2021.
There are few signs of recession now, though some investors are
concerned that wage growth has been slow even as the unemployment
rate has fallen to its lowest since 2000. BNP Paribas forecasts the
$1.5 trillion tax cuts will add a mere 0.5% to economic output this
year and some investors have expressed concern that companies have
devoted more of the proceeds to buying back their stock than to
raising worker wages.
"It generates asset [price] growth but doesn't necessarily
generate economic growth," said Alvise Marino, a currency
strategist with Credit Suisse Group.
There's little on the horizon threatening to change the dynamic
of robust expansion in the U.S. and "stagnant" growth in Europe,
said Luke Hickmore, a senior investment manager at Aberdeen
Standard Investments. He said the dollar could gain another 5%-10%
on top of the 5% it's gained since February. "There's no way the
dollar's stopping," Mr. Hickmore said.
Write to Daniel Kruger at Daniel.Kruger@wsj.com
(END) Dow Jones Newswires
May 20, 2018 08:14 ET (12:14 GMT)
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