The worst is over for the $10 trillion U.S. Treasury market, following the biggest quarterly rout since 2010, according to Wall Street's largest bond-trading firms.
After rising to as high as 2.4% last month, from 1.88% at the end of 2011, the yield on the benchmark 10-year note will finish 2012 at 2.49%, according to the average estimate in a Bloomberg News survey of the 21 primary dealers that trade with the Federal Reserve. That matches the findings of a January poll, suggesting that the market isn't ready to declare a bear market in bonds after a 30-year bull run.
Signs of strength in the economy, which caused a 5.56% loss in bonds maturing in 10 years or more last quarter, may fade in the second half of 2012, the dealers said. Tax cuts are expiring, $1 trillion of mandatory federal budget cuts are due to kick in and $100-a-barrel oil is eating into consumer spending. With inflation in check, Fed Chairman Ben S. Bernanke said recently that the central bank will consider further stimulus, even after upgrading its economic outlook March 13.
“The backup that we've seen over the past three or four weeks was not fully justified by what we're seeing in the data,” said Aneta Markowska, a senior U.S. economist at primary dealer Société Générale SA. The 10-year yield will end the year at 2.25%, she said March 27.
DEALER HOLDINGS
Primary-dealer holdings of U.S. government debt rose to $91 billion last month, from a net bet against the securities of $53.4 billion in May, according to the Fed. In the survey, 15 dealers said the odds are that the Fed will need a third round of bond purchases, or quantitative easing, to bolster the economy.
Recent housing reports show that a key part of the economy remains under pressure. The Commerce Department said March 23 that new-home sales fell to an annual pace of 313,000 in February, the slowest since October, from 318,000 in January, which was weaker than previously reported. The National Association of Realtors said existing-home sales eased to a rate of 4.59 million last month, from January's 4.63 million.
The economic recovery isn't yet assured and unemployment remains too high, Mr. Bernanke told ABC News anchor Diane Sawyer in an interview March 27.
The remarks came a day after Mr. Bernanke said in a speech that the drop in the unemployment rate to 8.3% may reflect “a reversal of the unusually large layoffs that occurred during late 2008 and over 2009.” Significant further improvement likely will require faster growth, he said. The Fed hasn't tightened monetary policy with joblessness at the existing level since it fought surging inflation in the 1980s.
“In the past week, Bernanke's gotten in front of every microphone he could find and gotten the market to realize that we shouldn't have priced out QE3, and even if you don't think it's going to happen, you have to attribute some sort of probability to it, and that he's going to stay accommodative and potentially increase accommodation,” John Briggs, a U.S. government bond strategist at primary dealer RBS Securities Inc., said March 28.FORECAST RANGE
Yield forecasts at the primary dealers range from 2% at RBS, Scotia Capital and Barclays Capital, to 3% at Deutsche Bank AG, Jefferies & Co. Inc. and BMO Financial Group.
Even if the most bearish forecasts prove true, yields will remain below the average of 3.85% over the past decade, 4.98% over the past 20 years and 6.48% since 1982.
The bull market for bonds began after then-Fed Chairman Paul Volcker began to lower borrowing costs from a high of 20% in 1980 after taming inflation.
President Barack Obama needs the support of the bond market to help finance a budget deficit projected to exceed $1 trillion for the fourth year as he runs for re-election in November.
While the amount of marketable debt outstanding has more than doubled to $10.2 trillion, from $4.34 trillion in mid-2007 as the U.S. sold bonds to pay for spending programs designed to pull the economy out of the worst financial crisis since the Great Depression, interest expense equaled 3% of the economy in fiscal 2011, which ended Sept. 30. That's down from 4% in 1999, when the U.S. ran budget surpluses.
Mr. Bernanke helped spark last quarter's sell-off when the central bank upgraded its assessment of the economy at its March 13 policy meeting. Losses in long-term bonds were the most since they tumbled 8% in the fourth quarter of 2010, according to Bank of America Merrill Lynch indexes, and compare with a 3.22% return for company debt and a 12.6% gain in the S&P 500, including reinvested interest.
Traders immediately reduced bets that the central bank would favor more bond purchases, and moved forward the date at which they anticipated the Fed would raise interest rates to 2013, from late 2014.
“At this point in the policy cycle, it is common for market participants to get ahead of themselves,” Vincent Reinhart, chief U.S. economist at primary dealer Morgan Stanley Smith Barney LLC and a former senior Fed official, said March 28. “The market's got a rosier view of the outlook.”
