By Min Zeng
The bond market rout is deepening.
The yield on the U.S. benchmark 10-year Treasury note rose to a 17-month high Thursday, following the biggest monthly increase in November since 2009. The yield recently was 2.477%, according to Tradeweb, compared with 2.365% Wednesday. Yields rise as bond prices fall.
Selling Thursday was driven by higher oil prices, which have extended Wednesday's rally after the Organization of the Petroleum Exporting Countries reached a deal to curb the continuing oil supply glut. Higher oil prices tend to boost inflation expectations, which chip away at bonds' fixed returns over time and is a big threat to long-term government bonds.
The oil move drove investors to sell Treasury debt and buy Treasury inflation-protected securities on Thursday. The allocation sent the 10-year Treasury note's yield premium over the 10-year TIPS to 1.98 percentage points, the highest since Oct 2014.
That level suggests that investors expect U.S. inflation to run at an annual rate of 1.98% on average over the next 10 years. Known as the 10-year break-even rate, it had soared by 1.36 percentage points shortly after the Brexit vote. The break-even rate last traded at 2% -- the Fed's inflation target -- in September 2014, a level some analysts say is likely to break soon if inflation bets gain more traction.
A solid U.S. manufacturing release Thursday boosted optimism toward the U.S. growth outlook, driving more investors to sell Treasury debt -- typically a haven when the economy falters.
The U.S. nonfarm payrolls report isdue Friday, one of the most important monthly economic statistics. Traders say an upbeat report could fuel more selling in bonds.
The 10-year Treasury yield has soared by more than 1 percentage point from its record low set in July. The selloff has been intensifying after the U.S. election in early November. Investors are betting that the prospect of expansive fiscal and economic policy under the new U.S. administration would lead to stronger growth, higher inflation and potentially a faster pace of interest-rate increases by the Federal Reserve.
This represents a big shift away from the notion of soft growth and low inflation that had been a main driver sending investors piling into Treasury debt and sovereign bonds in other developed countries, driving bond yields to historic lows this summer.
Higher Treasury bond yields have rippled globally as the selloff wiped out more than $1 trillion in November from the global government bond universe, based on the changes of market value in Bloomberg Barclays indexes data.
Some of the world's large money managers have changed their view that yields would stay lower for longer.
"We are moving to a new regime in the bond market," said Nick Gartside, international chief investment officer of global fixed income at J.P. Morgan Asset Management, which had $1.8 trillion assets under management as of Sept. 30.
Mr. Gartside said he believes that Treasury bond yields had hit rock bottom in July following a 35-year span of lower yields. He said the 10-year yield would rise to 3% during 2017 -- a level where it had last traded in early 2014.
Reflecting his yield expectation, he has cut his Treasury bondholdings recently and preferred corporate bonds. He said bonds sold by lower-rated corporate-debt issuers are attractive amid a brighter growth outlook.
Some investors believe bond yields have room to rise. They argue that higher Treasury yields are a healthy sign as it reflects a brighter assessment of the economy. The 10-year yield traded at 3% in early 2014. Even with the rise this month, it is less than half of the level where it had traded in 2007.
The sharp rise in yields reminds investors of the so-called taper tantrum episode in 2013, when worries over a cut in the Fed's bond-buying program rattled the bond market. Now, some investors are concerned that the bond rout may again spook investors and cause heavy outflows from bond funds. Analysts warn that this would generate further selling pressure in the bond market and lead to much higher yields from here.
"It is absolutely a risk," said Erik Schiller, senior portfolio manager for global government bonds at Prudential Financial Inc.'s fixed-income unit.
U.S. bond mutual funds that target Treasury securities have suffered 11 consecutive weekly net outflows through Nov. 23 totaling $175.275 million, according to fund tracker Lipper. It is the longest losing streak since 2010.
So far the pace of redemption -- $16 million a week during this period -- is moderate. One week in November 2013, a weekly outflow surged above $300 million. For the year, the fund group has lured a net $1.779 billion inflow, as a sharp decline in yields earlier this year sent bond prices soaring.
"The average retail investor will be slow to change direction in their mutual fund portfolios," said Tom Roseen, head of research services at Thomson Reuters Lipper. "Maybe the baby boomers will hold pat, fearing what some think to be an equity rally that is getting pretty long in the tooth and preferring bonds."
Bill Irving, portfolio manager at Fidelity Investments, which had $2.1 trillion assets under management at the end of October, said he scooped up Treasury debt from the selloff.
Mr. Irving said he is skeptical bond yields could rise sharply from here because that would rattle stocks and other riskier markets, tighten financial conditions and potentially drag down the growth momentum.
While higher yields shrink the value of outstanding bonds, they allow investors to invest new cash at more attractive yields. That is a boon for people near retirement or who have already retired as they have been struggling to generate income in a low-yield world.
Higher yields are a boon to pension funds and insurance firms too. These institutional investors need high-grade long-maturity debt to match their long-term obligations. Traders say some have been buying long-term Treasury debt over the past week.
"Over the long haul, reinvesting at higher rates will boost your overall returns," said Gemma Wright-Casparius, senior portfolio manager of the fixed-income group at the Vanguard Group.
Write to Min Zeng at email@example.com
(END) Dow Jones NewswiresDecember 01, 2016 12:48 ET (17:48 GMT)
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