Bond investors are gaining confidence that Federal Reserve Chairman Ben S. Bernanke will unwind the central bank's unprecedented $3.3 trillion balance sheet without sparking a crash similar to 1994, when then-Chairman Alan Greenspan surprised the market by doubling benchmark lending rates in 12 months.
Although sovereign-debt levels have more than quadrupled to $23 trillion, yields for 10-year Treasuries are 5 percentage points lower than they were in 1994, and forward measures show the 1.74% level rising only to 2.04% in a year. Policy- makers' forecasts of no rise in the target interest rate for overnight loans between banks until 2015 are dampening yields in a market dominated by the Fed's $1.84 trillion, or 15.4% of the $11.94 trillion in marketable U.S. debt.
Although BlackRock Inc. is trimming investments in longer-term Treasuries to protect against a rise in yields, and The Goldman Sachs Group Inc. invokes the memory of 1994, when U.S. bonds lost 3.35% as Mr. Greenspan didn't prepare investors for the speed of rate increases, money managers from J.P. Morgan Asset Management to Fidelity Investments contend that this time will be different.
That is partly because of Mr. Bernanke's clearer and frequent statements on what would cause central bank policy to change.
“The Fed has been very transparent, and their transparency should help offset the risks that were experienced in 1994,” said Edward Fitzpatrick, a money manager and head of U.S. rates at the JPMorgan Chase & Co. unit, which oversees $1.5 trillion. “There are still hurdles, not the least of which is that they have to end the quantitative-easing program before they would contemplate tightening.”
YIELDS RISE
Yields on 10-year Treasuries, the benchmark for everything from corporate bonds to mortgages, rose to 1.74% on May 3 after the Labor Department reported that the jobless rate fell to 7.5% last month, from 7.6% in March, as payrolls expanded by 165,000 jobs.
The Federal Open Market Committee said in a statement following a two-day meeting in Washington on May 1 that it will maintain its bond buying at the monthly pace of $85 billion and that it is prepared to raise or lower the level of purchases as economic conditions evolve. Policymakers also left in place their statement that they plan to hold the target rate at around zero as long as unemployment remains above 6.5% and the outlook for inflation doesn't exceed 2.5%.
Most Fed officials don't anticipate raising the benchmark rate until 2015, according to estimates provided with forecasts released after the March 19-20 FOMC meeting.
Confidence that the Fed can avoid triggering a 1994-style rout isn't universal.
“I worry now,” Lloyd C. Blankfein, chief executive of Goldman Sachs, said May 2 at a conference in Washington. “I look out of the corner of my eye to the "94 period.”
COMPLACENCY
Mr. Blankfein said investors are complacent due to record low rates for more than four years, and he recalled that the market was shocked by the losses caused two decades ago when they went up.
“Rates could rise rapidly for at least two different reasons,” said Antulio Bomfim, senior managing director at Macroeconomic Advisers LLC and a former Fed economist. “The Fed could bungle its communication effort and spook the market, or despite the Fed's best efforts on communications, the economic data could end up being a lot stronger than what people thought.”
With the central bank's asset purchases holding down rates, “at some point, you are going to have this spring-loaded effect, where once the Fed starts pulling back, maybe you get a little bit of inflation, 30-year yields will move up 50 to 75 basis points,” Rick Rieder, chief investment officer for fundamental fixed income at BlackRock, said in a Bloomberg Television interview April 29.
That “move leaves a real mark,” he said.
Investors buying $10 million in 30-year bonds at 2.83% would lose $874,000 if the yield rose 75 basis points to 3.58% by the end of 2014, according to data compiled by Bloomberg.
The value would decline by $1.2 million if the rate increased this year.
In 1994, the U.S. bond market fell 2.75%, the worst annual performance since 1978, according to Bank of America Merrill Lynch index data, as the central bank raised its benchmark rate to 6% by February 1995, from 3% 12 months earlier. Treasuries posted an annual loss of 3.35%, the worst performance until the 3.72% drop in 2009, according to the bank's Treasury Master index.
