Greenspan's Bond Conundrum Ripens Into an Enigma: Mark Gilbert
June 3 (Bloomberg) -- The 10-year U.S. Treasury note was a ``conundrum'' to Federal Reserve Chairman Alan Greenspan in mid- February at a yield of about 4.10 percent. After cracking the 4 percent barrier this week, it looks more like Winston Churchill's Russia: ``a riddle, wrapped in a mystery, inside an enigma.''
The median forecast of 62 of the finest minds in finance, surveyed by Bloomberg News in December, was for the 10-year bond to yield 4.78 percent by mid-year. Instead, the note pays about 3.9 percent, the lowest in more than a year. Barring a market crash in the next four weeks, that's quite a margin of error.
Bond mavens are now lining up to call for lower yields. Morgan Stanley Chief Economist Stephen Roach said earlier this week he's turning bullish on bonds, with a 3.5 percent level possible in the coming year. Bill Gross at Pacific Investment Management Co., never shy to predict an increase in value for the securities he owns, said May 18 that the 10-year rate could drop to 3 percent by the end of the decade.
Gabe Borenstein, managing director of global investments at Investec Holdings Ltd. in New York, predicts a 10-year yield of 2.5 percent in the current business cycle, which has 18 months or less to run. Higher energy costs, renewed wariness among indebted consumers, and continued recycling of dollars into Treasuries by overseas investors will help drive down yields, he says.
`Serious Recession'
``All of the economic forces point to a dramatic slowdown ahead which will turn into a serious recession, with almost no tools left to abort that possibility,'' says Borenstein, whose firm manages $100 billion globally.
David Rosenberg, chief economist for North America at Merrill Lynch & Co. in New York, published a May 4 laundry list of demographic reasons why bond yields might plummet ``to levels not seen in about half a century,'' as an ageing population shuns equities and shifts more of its retirement nest egg into fixed- income securities.
``The combination of an ever-greater share of the population heading into retirement age and rising life expectancy will likely boost the demand for bond duration income-generating assets,'' he wrote. ``The typical boomers, who helped drive the equity bull market from 1982 to 2000 as they moved through the peak `capital growth years' of the life cycle, are now beginning to enter `capital preservation' mode for the first time.''
Not So Puzzling
Richard Fisher, president of the Federal Reserve Bank of Dallas, called the 10-year yield ``less of a conundrum'' this week, simultaneously getting in a sly dig at the constitutional and economic woes besetting Europe. ``What we have in this country is a $12 trillion economy growing at between 3 and 4 percent,'' Fisher told CNBC on June 1. ``We have constitutional unity. Where are people going to put their money?''
Fisher also squirted some more fuel onto the bond fire by suggesting the Fed may be close to pausing in its campaign to push lending rates higher. The U.S. central bank has tripled its overnight target rate to 3 percent in eight moves in less than a year -- still low, though, when you consider that the annual pace of core inflation, excluding food and energy, is 2.2 percent.
A March study of historical rates by Menno Middeldorp, senior economist at Rabobank Nederland in Utrecht, the Netherlands, suggests that ultra-low interest rates are the norm, rather than the exception. ``U.K. interest rates were under 4 percent for almost 100 years before the early 1920s,'' he said. ``U.S. 10-year yields were below 4 percent for almost 80 years up to 1960.''
Skewed Expectations
Middeldorp points out that most bond-market participants haven't experienced low rates for long periods, which may skew expectations. ``It would be shortsighted to conclude that interest rates should move higher simply because one doesn't understand why they are below the average levels most people can remember,'' he wrote.
It certainly paid to bet on the persistence of low rates recently. Last year, you made a total return of almost 14 percent in local-currency terms on government bonds denominated in euros and maturing in 10 years and more, according to Bloomberg data. The gain on comparable U.S. bonds was 7.6 percent. So far this year, U.S. bonds have delivered 7.9 percent, outpacing the 7.3 percent available in Europe.
I can't help wondering whether we're near the point when apocryphal shoeshine boys start recommending bonds. Does it really make sense for pension funds to get paid just 4.25 percent for lending to the U.K. for half a century or to the U.S. for 30 years, or 4 percent on 30-year loans to Italy?
The ``this time it's different argument'' turned out badly at the turn of the decade for investors seduced by the promise of the Dow Jones Industrial Average reaching 36,000 and the Nasdaq Composite Index only ever going up. Let's hope there's a gentler, kinder solution to the bond-market puzzle. |
