US bond market braces for higher yields

Wall Street expects higher Treasury yields next year, and one primary dealer has the 30-year bond hitting 6 percent for the first time since 2000. But investors will have to be nimble, since variables such as the pace of US growth, high US deficits and Europe's lingering debt crisis probably means that any rise in yields proceeds in a zig-zag pattern rather than a straight line.
Yields, which move inversely to the price of bonds, slumped for much of 2010 as fears that the United States would slip back into recession drove a safety bid for bonds, but yields recovered as economic data improved.
A deal in December to extend US tax cuts and temporarily cut the payroll tax drove 10-year yields to a seven-month peak near 3.57 percent and left Wall Street betting that 2010's halting recovery would blossom into self-sustaining, if not overwhelming, economic growth in 2011.
"My expectation after the fiscal stimulus from the payroll tax holiday is the ranges of yields are just naturally going to be higher" next year, said Michael Mata, who manages assets worth $600 million for the ING Global Bond Fund in Atlanta.
A 3 percent to 3.20 percent range should be a floor for benchmark 10-year yields, he said, "and 3.75 percent to 4 percent will be touched sometime in the first half of next year."
That would take yields back to levels seen in early 2010, when the 10-year peaked at 4.01 percent before plunging on fear of a double-dip US recession and Europe's debt woes. The 10-year yielded 3.36 percent on Thursday, about 100 basis points above its 2010 low.
A recent Reuters poll of primary dealers had a median 2011 growth forecast of 3.05 percent, up from 2.7 percent in early December. Goldman Sachs expects the economy to expand at a 3.4 percent rate. Analysts said that trend will draw investors toward equities, commodities and inflation-linked securities and reverse the massive inflows into bond mutual funds seen in 2010.
Domestic investors have yanked some $2 trillion out of zero-rate money market funds over the past 20 months, according to iMoneynet data, with much of it landing in bond funds.
Mata said much of that money will now find its way into equity funds in 2011. "It won't be a tidal wave out of Treasuries, but this year the flows were just tremendous." In what could be a preview of things to come, Investment Company Institute data showed investors pulled $8.6 billion from US-listed fixed income funds in the week to December 15, the biggest weekly outflow in more than two years.
Another force that could undermine Treasuries is a growing distaste for sovereign debt, particularly that issued by developed countries with high deficits and subpar growth.
Citigroup's chief economist said this year that Europe's debt turmoil may be the "opening act" of a debt crisis that could even infect the United States.