Business & Finance

Bonds gain on Fed rate pledge, curve seen flattening

HONG KONG : US Treasuries pushed higher on Wednesday and benchmark yields dipped back near record lows hit the previou
Published August 10, 2011

 HONG KONG: US Treasuries pushed higher on Wednesday and benchmark yields dipped back near record lows hit the previous day after the Federal Reserve's pledge to keep rates near zero for at least another two years prompted more investors to pile in.

The Fed downgraded its assessment of the economy, promised to keep rates near rock bottom until 2013 and it said it will consider other measures to revive growth after shock revisions to GDP data have stoked worries about a renewed recession.

Analysts said the Fed's signals should prompt investors to feel more comfortable shifting into longer-term maturities and cause a broad flattening of the yield curve, especially with two-year yields falling to Japanese-like record lows of just 0.1647 percent.

The Fed action marked a milestone in the array of aggressive measures taken to lift the economy out of its weak recovery following the worst recession since the Great Depression, including tripling the size of its balance sheet via quantitative easing asset purchases.

"The clear short-term implication from a rates perspective is that the intermediate sector should outperform, with the curve flattening to progressively longer maturities," said fixed-income strategists at Deutsche Bank in a note to clients.

During the Asia session, T-note futures and 30-year bonds fell, as a nearly 3 percent rebound in regional equity markets prompted some profit-taking -- even as the Fed move was seen as broadly positive for bonds and helped lift medium-term paper.

Treasuries have soared over the past two weeks as the surprisingly deep downward revisions to GDP growth, the flaring euro zone crisis and sharp selloff across stocks have sparked a big rush into what is still the world's safe-have bond -- even after the S&P rating slash.

A sustained drop in long-term Treasury yields and "term premium" -- the premium for holding the risk of longer-dated debt -- should also help boost riskier assets over time, the Deutsche analysts said.

The next option for the Fed was likely to boost its asset purchases further -- QE3 -- or lengthen the maturity of its current Treasury holdings out to the long end of the curve.

Lou Crandall, chief economist at Wrightson ICAP, said that based on Fed Chairman Ben Bernanke's recent hierarchy of policy options, "increasing the size of the Fed's portfolio or tilting its composition toward riskier assets is next in line."

Goldman Sachs said a third round of quantitative easing is now likely and that the Fed would launch it later this year or early in 2012.

BELLY OUTPERFORMS

Ten-year cash notes were up 5/32 in price to yield 2.2574 percent, down 2 basis points on the day but up from the record low of 2.038 percent touched after the Fed statement.

Five- and seven-year notes outperformed on the curve, with the five-year yield falling 4 bps to 0.9709 percent. On BrokerTec, five-year notes were the most traded coupon on the curve.

The 30-year yield was up 2 basis points on the day at 3.664 percent, causing the 10s/30 curve to steepen to 140.3 bps -- the steepest in nine months and approaching the all-time peak of 157 bps reached last year during the broad drop in bond yields.

September T-note futures fell 12/5/32 to 129-14/32 on very active volume of more than 110,000 lots in Asia.

Over the medium term, some portfolio managers in Japan may shed some of their holdings of Treasuries in favour of JGBs since the yield spread between them is collapsing further, analysts said.

"Investors could shift their funds into JGBs from Treasuries. Investors would feel more safe to hold their assets in their own currency if there is less attractiveness in spreads," said Hiroki Shimazu, senior market economist at SMBC Nikko Securities.

The spread of five-year Treasury yield over similar JGBs has collapsed to just 60 bps from highs near 180 bps earlier in the year and a pre-crisis spread of about 350 bps.

But in the near-term, institutional investors have sold Treasuries to take profits as yields dropped and will be looking to buy on any back-up in yields, they said.

Japan's Ministry of Finance is also likely to keep buying Treasuries as it allocates some of the dollars accumulated in its big one-day bout of currency intervention to weaken the yen last Thursday, which some have estimated at $50 billion.

Even before Japan's intervention, central banks have accelerated their purchases of Treasuries last week after the debt ceiling debate was settled and a technical default averted.

In the week ending last Wednesday, the Fed's holdings of Treasuries for other central banks jumped $14 billion.

Treasuries remain volatile and could see a sharp bout of profit-taking if equities sustain a rebound in coming days.

"The Treasury market is clearly in adult-swim only mode, with remarkably sharp and choppy price action," said David Ader, government bond strategist at CRT Capital.

 

Copyright Reuters, 2011

 

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