Big Treasuries selloff still seen far off, even as yields surge
NEW YORK, Jan 4 (Reuters) - U.S. Treasuries have been big losers so far in the year just begun, with yields rising to the highest levels in eight months on speculation that the Federal Reserve may end its bond purchases earlier than many thought.
Some investors, however, say that the market may be getting ahead of itself and that a still sluggish economy and further Fed stimulus is likely to hold rates down near historically low levels for some time yet.
Treasury yields jumped after minutes from the Fed's December meeting, released on Thursday, raised the prospect that the central bank may end its bond purchase program before year-end, sooner than most expected.
"I think the market over-reacted a bit," said Gregory Whiteley, government bond portfolio manager at DoubleLine Capital in Los Angeles.
"The economy here, in Europe and in Asia, still faces considerable ongoing headwinds." And, "the fiscal situation makes it more difficult to end purchases than anyone is saying out loud."
A compromise struck by Congress this week to avert the worst of the so-called fiscal cliff of tax hikes and spending cuts has also dampened demand for safe-haven bonds, though lawmakers face much tougher battles ahead over how to cut spending and resolve the gaping U.S. deficit.
The question of how and when the 30-year bull run in Treasuries will end has been debated for years, but those gambling on dramatic increases in yields have found that betting against the Fed is a losing proposition.
PIMCO, the world's largest bond fund, was a high profile loser in 2011 when Bill Gross made a very public bet against the bonds, which he later described as a mistake.
Some members of the Fed expressed concern in the December meeting that continued bond purchases will make it harder to exit from the ultra-loose monetary policies, "citing concerns about financial stability or the size of the balance sheet."
But investors said that discord among Fed voting members was not new, and that the hawks were still unlikely to win over Chairman Ben Bernanke who has said loose monetary conditions will need to persist even as the economy improves.
"I still think that the core of the FOMC - Bernanke, Yellen, and Dudley will be very aggressive on the monetary easing side unless they are fully convinced that we are in a strong sustainable recovery or there is a significant pickup in inflation, " said Eric Stein, portfolio manager at Eaton Vance in Boston, Mass.
YIELDS EDGING UP
That's not to say that yields won't rise from here, though increases are seen likely to be contained.
Credit Suisse sees benchmark 10-year note yields as having moved into a higher range of around 1.82 percent to 2.12 percent, and expects that the notes may extend yield increases to 2.25 percent by the end of the first quarter, up from 1.92 percent on Friday.
The yields have jumped from 1.75 percent at year-end and from 1.57 percent at the end of November.
"The market may have over-reacted a bit to the Fed news but we are in an environment of an improving economy," said Carl Lantz, interest rate strategist at Credit Suisse in New York.
The problem of rising bond yields, however, is that they can also dampen borrowing, which has the circular effect of harming economic growth and sending yields back lower. Thirty-year mortgage rates have risen by around 20 basis points since the end of November, to around 2.35 percent, according to data by Angel Oak Capital Advisors.
"If mortgage rates back up materially, the risk is that the recovery will slow down, so it's self-correcting," said Lantz. "We may get all excited about a rates bear market, the beginning of the end, but with the Fed on hold it makes it really hard to sustain a selloff in Treasuries."
Lantz expects benchmark notes yields may end the year near where they started, at around 2 percent.
Expectations of new wrangling in Washington over the debt ceiling and fears that the United States could suffer a new downgrade of its credit rating may also bring safety bid back to bonds in the coming months.
"We think rates will back up a little bit over the next couple of weeks, and then probably rally as we head into the debt ceiling debate," said Michael Schumacher, head of global rates strategy at UBS in Stamford, Connecticut.
A second downgrade of the U.S. credit rating may also spark a flight-to-safety bid for bonds, if any downgrade is contained to one notch, analysts said.
Treasuries rallied after Standard & Poor's cut the U.S. AAA rating by one notch in mid-2011.
Moody's Investors Service said on Wednesday that the United States must do more than this week's fiscal cliff measures to remove the threat of a downgrade.
"It's a relatively benign downgrade if the U.S. is AA-plus , on par with other issuers," said UBS' Schumacher. "A bigger risk would be multiple-notch downgrades over the course of the year, to the point that some investors start to back out then. But we're not there yet."