By Min Zeng
For bond investors, the year was all about timing.
Buy-and-holders could have slept through 2016 and would hardly have noticed the difference. The yield on the benchmark 10-year Treasury note closed at 2.446% on 2016's last trading session, up from 2.273% at the end of 2015, generating the second consecutive year of price declines for the nearly $14 trillion market.
But during the year, bond bulls had their day. Yields, which fall as prices rise, tumbled nearly a percentage point by the summer, with the 10-year hitting a record low of 1.366% in early July.
The remarkable rally was then followed by a the biggest quarterly selloff in more than two decades. The Treasury yield climbed 0.841 percentage point between October and December, the largest quarterly gain since 1994.
"There have been a lot of unexpected twists and turns throughout the ride in 2016," said Scott Buchta, head of fixed-income strategy at Brean Capital.
The extremes tell a story of fears and hopes: Investors flocked to the world's largest bond market for safety as 2016 started, when a sinking Chinese stock market and yuan heightened worries about the global economy and caused a swoon in U.S. stocks. Bonds got another booster after the U.K.'s vote in late June to leave the European Union.
But over the past few months, global data and Federal Reserve pronouncements drove investors to expect stronger growth, higher inflation and potentially a faster pace of interest-rate increases.
The growth narrative has been accentuated by the prospect of greater spending, lower taxes and lighter regulations under Donald Trump, who was elected president in November. Inflation chips away bonds' fixed returns over time and is considered a big threat to long-term government bonds.
In addition, higher fiscal spending typically requires more issuance of Treasury bonds for funding, and investors are concerned that more debt supply would pressure yields higher at a time when demand for bonds has diminished.
The recent selloff has shrunk the total return from Treasury bonds to 0.8% this year through Thursday, according to Bloomberg Barclays bond indexes data. The S&P 500 stock index logged a 12% return over the same period, according to FactSet. The return includes price changes and interest or dividend payments.
In the U.S. fixed-income market, junk bonds, or corporate debt sold by lower-rated firms, were the rock star, returning 17% this year through Thursday, according to the Bloomberg Barclays data. Higher-rated U.S. corporate bonds have logged a return of5.8%, and U.S. municipal bonds have posted a return of 0.2%. Treasury inflation-protected bonds, or TIPS, have posted a return of 4.3% amid strong demand for inflation protection.
Despite the rise, Treasury yields are still low from a historical standpoint. The 10-year yield is less than half its trading level in 2007. The yield's record close was 15.819% on Sept 30, 1981.
Some analysts believe that the long cycle of lower yields is coming to an end and that the record-low close set in July marks the bottom of the 10-year yield.
Others are hesitant, given that the bond market has wrong-footed those calling for the end of the bond bull market in recent years. They caution that investors betting on higher yields have pinned high hopes on Mr. Trump's fiscal stimulus and its boost to the economy. If Mr. Trump's policy outcome fails to deliver, growth optimism may wane, and investors may turn back to bonds.
"The market pendulum has been swinging into euphoria with the prospect of swift fiscal stimulus," said Jason Evans, co-founder of hedge fund NineAlpha Capital LP in New York.
At the same time, rising bond yields themselves can cut growth momentum. Treasury bond yields are a benchmark used to help set long-term borrowing costs for U.S. consumers and businesses. U.S. mortgage rates, for example, have risen over the past months, which may curb refinancing activities and hurt the housing market.
In a sign of renewed caution, the bond market has regained some poise lately. The 10-year yield has pulled back after closing Dec. 16 at 2.6%, the highest since September 2014.
Write to Min Zeng at firstname.lastname@example.org
(END) Dow Jones Newswires
December 30, 2016 17:38 ET (22:38 GMT)
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