By Daniel Kruger and Sam Goldfarb
Yields on U.S. government bonds have rebounded from
near-historic lows hit just two months ago, sending one of the
clearest signals yet that investors' recent recession fears have
waned.
A series of developments have combined to boost the economic
outlook, spurring selling in bonds and powering a steep climb in
the 10-year Treasury yield -- a key benchmark that helps set
borrowing costs on everything from corporate debt to mortgages.
Those include the Federal Reserve's cuts to short-term interest
rates, steps toward a trade agreement by the U.S. and China and a
series of economic reports that turned out better than some
investors had feared.
The yield on the benchmark 10-year U.S. Treasury note settled
Thursday at 1.815%, according to Tradeweb. Though it has drifted
lower in recent days, that was still up from 1.75% at the start of
last week and in early September at below 1.5%, when fears of a
global economic slowdown drove investors to the relative safety of
government debt. Yields rise when bond prices fall.
The yield's climb marks a significant reversal for the bond
market. At one point this summer, U.S. yields were falling so
quickly that some investors and analysts wondered if they could
drop below zero, joining the trillions of dollars of debt with
negative yields around the world. Yields on longer-term Treasurys
also slipped below shorter-term yields, a phenomenon known as an
inverted yield-curve, which has proved one of the financial
markets' best predictors of a looming recession.
Highlighting the turnaround in sentiment, the amount of
negative-yielding bonds has dwindled by several trillion dollars.
And the U.S. yield curve has almost completely uninverted, with
yields on benchmark Treasurys getting progressively higher from the
12-month bill all the way to the 30-year bond.
The 10-year yield remains very low -- sitting closer to the
all-time low of 1.366% it reached in 2016 than the 3.2% level it
briefly hit about a year ago when the Fed was still raising
interest rates. And few investors expect the yield to climb near 3%
in the near future, due to slow economic growth and low bond yields
overseas, which tend to make U.S. debt look attractive in
comparison.
Nonetheless, many investors think yields have room to rise as
more people sell bonds to buy riskier assets. The net number of
fund managers expecting global economic growth to improve over the
next 12 months posted its biggest monthly jump on record in data
going back to 1994, according to a survey by Bank of America
Merrill Lynch. More than half of those surveyed said stocks will be
the best-performing asset class in 2020, while only about 5% picked
government bonds.
"Based on the current state of the economy, yields are probably
still too low," said Gershon Distenfeld, co-head of fixed-income at
AllianceBernstein.
Many investors expect the economy to grow at a pace of about 2%
next year. While that is slower than the 2.9% growth achieved last
year, it stands in line with recent long-term trends and is a far
cry than the contraction investors worried about earlier in the
year.
Increased risk-taking is just one reason why a brighter economic
outlook is denting bond prices. Continued growth could lead to
higher inflation, which is a major threat to longer-term bonds
because it erodes the purchasing power of their fixed payments. It
could also at some point cause the Fed to start raising interest
rates again, pushing up short-term yields in particular.
The average inflation rate investors expect during the next 10
years -- measured by the gap between the yields of 10-year U.S.
government debt and Treasury inflation-protected securities of
similar maturity -- has risen to about 1.65% from roughly 1.55% at
the end of last month. The 10-year break-even rate climbed 17 basis
points over six sessions at the start of the month, its largest
six-day gain since November 2016.
In congressional testimony Thursday, Fed Chairman Jerome Powell
said the U.S.-China trade battle had contributed to declines in
domestic manufacturing activity and that uncertainty stemming from
the conflict had generally weighed on business sentiment.
Still, he reiterated his view, expressed before a separate
congressional panel on Wednesday, that the economic outlook remains
favorable, in part because of the Fed's rate cuts. He indicated the
central bank was comfortable with the current level of interest
rates, barring a change in the economic outlook.
Mr. Powell also played down the risk of much higher inflation,
saying he saw "no sign that things are overheating or anything like
that."
While the pace of U.S. job growth has decelerated and
manufacturing output has weakened, consumers -- who account for
more than two-thirds of U.S. economic activity -- have continued to
fuel the economy with their spending. Further boosting investors'
optimism, the U.S. and China have moved toward what has been billed
as "phase one" of a trade agreement, notwithstanding occasional
tensions during negotiations.
"Phase one, whatever it is, is a positive for business" and the
broader economy, said Anne Mathias, an interest-rate and currency
strategist at Vanguard Group.
Many investors still expect the rise in U.S. yields to be
constrained by low bond yields overseas, where data in Europe has
shown an economy struggling with low inflation and weakening
manufacturing output.
Foreign investors are buying Treasurys at the fastest pace in
almost a decade, attracted by a 10-year Treasury yield that stands
more than 2 percentage points higher than German debt of the same
maturity.
Still, yields in France and Belgium rose above zero last week
for the first time in months, lifted by the European Central Bank's
September move to cut interest rates and resume bond purchases.
Progress toward a trade deal between the U.S. and China could also
provide a boost to government debt yields in Europe, because
export-driven economies such as Germany's have been hard-hit by
slowing growth in China stemming from rising tariffs, said Jeffrey
Elswick, director of fixed income at Frost Investment Advisors.
"The data's going to get better in the U.S. and globally," which
could push the 10-year Treasury yield as high as 2.5% next year, he
said.
Even with the increase in Treasury yields, the environment
remains very favorable to most corporate borrowers. Thanks in part
to strong demand for corporate debt, the average U.S.
investment-grade corporate bond yield was roughly 3.0% Tuesday, up
from around 2.8% in early October but still down from 4% in
January.
Underscoring the ability of companies to borrow large sums, the
drugmaker AbbVie Inc. sold $30 billion of bonds Tuesday to help
fund its acquisition of Allergan PLC. That marked the
fourth-largest investment-grade corporate bond sale on record, just
ahead of Comcast Corp.'s $27 billion sale last year.
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Write to Daniel Kruger at Daniel.Kruger@wsj.com and Sam Goldfarb
at sam.goldfarb@wsj.com
(END) Dow Jones Newswires
November 14, 2019 17:38 ET (22:38 GMT)
Copyright (c) 2019 Dow Jones & Company, Inc.