US Treasury Bond prices had one of their biggest moves in recent times on Friday (16/08/13) with the yield on the widely followed ten year bond moving out to 2.83% – a level not seen for over two years according to historical data from Reuters. Moreover, the ten tear bond yield has in fact now moved up by 75% from the 1.6% seen at the start of May 2013. These are substantial moves in anyone’s language and as such should not be overlooked or ignored.
Key question then – what is behind these momentous events in the normally staid world of bond trading? The answer is actually quite straightforward and what we, per usual, flagged months earlier than the masses in the New Year edition of our magazine – it’s the simple realisation that after five years of cheap money and with central bank asset purchase coming to end (and with it the artificially depressed yields seen in Govt bond markets) that the long bull market bonds is OVER.
It seems that we are not alone in this thinking now however, and no lesser a mortal that the world’s largest and most renowned fixed income investor, PIMCO boss Bill Gross agrees, posting a series of uncharacteristically desperate tweets on Friday last, that culminated with the following from the @Pimco account “Gross: I am tweeted out – just like the bond market. Must be the bottom!”
Sadly for Mr Gross that may be a case of wishful thinking…
Strategists at US Bank JP Morgan produced a timetable for Fed tapering last week which looks a follows:
Projected Fed asset purchase in US$ billions
As we can see, JPM’s expectation is that there will be a and clear and concerted reduction in the level of asset purchases undertaken by the Federal Reserve as it seeks to wean the markets of the opiates of free money & quantitative easing. As with any exercise in “withdrawal”, we can expect the addict to undergo “cold turkey” and this will likely not be a pretty or painless process. The patient will have to cope with a near 50% reduction in the strength of his fixes within a month and the dose will then be sharply reduced once again by the start of summer 2014. Pleas for a delay in starting the treatment will likely fall on deaf ears too, not least because several leading investment banks and other market commentators have said that the Federal Reserve would risk losing credibility in the markets if it does not move to taper its intervention in line with the statements made by Ben Bernanke back in May. That’s something that US authorities just couldn’t countenance.
As the QE and Asset purchase programmes are tapered, not only will the Fed be buying less paper in the markets on a month by month basis, it will also have to consider what it’s going to do with the assets it has already bought through its permanent open market operations or POMO program. To put this into context As of the middle of June this year the Feds Balance sheet moved north of US$3 trillion bolstered by its on-going purchases of Treasury Bonds and Mortgage Backed Securities or MBS. This a colossal sum. For instance, it’s nearly twice the size of the entire national debt of the UK and at some stage US authorities will need to sell this inventory as they seek to deleverage the central bank’s balance sheet. Timing those sales will be critical if they wish to avoid swamping the markets and massive making losses to boot.
Of course, markets and in particular bond and interest rate markets, are forward looking and are anticipating just that as we can see from the chart below of the price for the US 10 year treasury note. We can clearly see that the rise in yields/fall in price seen last week has taken the 10 year price back below the uptrend support that dates all the way back to the end of June 2007. Whilst it’s true to say that one swallow a summer does not make, it’s hard to see what the positive factors are for bond prices given what we have discussed above. The 10 year finished last week at a price of US$123.875, but if we see it stay below the uptrend line and move through US$123.60 the high in March 2009, then a move back to US$121.58 should not be discounted.
Richard Jennings, CFA. Titan Investment Partners