Bond Danger Compounded by U.S. Extending Treasury Maturities

by Daniel Kruger

Job seekers talk to potential employers during a Princeton Area Chamber of Commerce job fair in Princeton, Illinois. The labor market surged in January, capping the biggest three-month employment gain in 17 years. Photographer: Daniel Acker/Bloomberg

(Bloomberg) -- Uncle Sam is going long.
As the insatiable demand for Treasuries pushes down yields, the U.S. has locked in low-cost financing for years to come by issuing more long-term debt. The average maturity of Treasuries is now poised to reach an all-time high this year.
The shift is saving money for American taxpayers -- but it’s also made Treasuries more perilous for bond investors as the strength of the U.S. economy bolsters the Federal Reserve’s case for raising interest rates. Holders stand to lose about $570 billion if yields rise by a percentage point, data compiled by Bloomberg show. In 2009, it was $170 billion.

Treasuries are “becoming detached from U.S. economic fundamentals,” said William Irving, a Merrimack, New Hampshire-based money manager at Fidelity Investments, which
oversees about $2 trillion. “I don’t think it’s a great time to buy.”
Long-term Treasuries have been some of the best investments around in the past year as oil tumbled, deflation emerged in Europe and a global slowdown threatened to drag on the U.S. recovery. The 30-year bond, the longest maturity security issued by the Treasury, returned 29 percent, double that for U.S. equities. The rally accelerated in 2015, pushing down yields to a record-low 2.22 percent on Jan. 30.
A year ago, yields were closer to 4 percent.
The demand for long bonds helped the Obama administration trim the nation’s short-term borrowing, which ballooned as U.S. ran trillion-dollar deficits to restore demand after the credit crisis. Treasuries due three years or less make up 48 percent of the market for U.S. debt, versus 58 percent six years ago.

Debt Burden

The share of bills, due in one year or less, is approaching the least since the 1950s.
That’s given the U.S. more time to repay its obligations. The average maturity has reached 68.7 months, or two months short of its high in 2001. With the U.S. budget deficit falling to a six-year low, the government is in better shape to finance its record debt burden when interest rates do rise.
The U.S. pays less in interest now than it did in 2008, even after the amount of U.S. debt outstanding more than doubled to $12.5 trillion.
Instead, it’s bond investors who are being exposed to the brunt of the risk as the Fed looks to end its six-year-long policy of holding benchmark rates close to zero.
Based on a bond-market metric known as duration, Treasuries are more vulnerable to losses when yields rise than at any time since at least 1997, according to Bank of America. The potential losses are the greatest for 30-year bonds.

Employment Gains

If yields increase 1 percentage point in the next year, the 30-year bond would lose 15 percent of its value, data compiled by Bloomberg show. Forecasters surveyed by Bloomberg expect the yield to reach 3.35 percent by year-end.
Last week’s jobs report provided the strongest evidence yet the economy will finally produce the kind of growth that prompts investors to turn away from Treasuries.
The labor market surged in January, capping the biggest three-month employment gain in 17 years. Wages, which failed to grow enough last year to stir inflation expectations, jumped by the most since 2008. Yields on Treasuries across all maturities soared, those on the 30-year bond rising by the most on a weekly basis since 2009. The yield ended at 2.53 percent Friday. It was 2.5 percent on Monday at 7:44 a.m. in London.
After the report, traders moved up their expectations for when the Fed will start increasing rates. They’re pricing a 26 percent chance the central bank will raise rates in June, from 14 percent at the end of January.

‘Downward Pressure’

The bond market’s inflation outlook over the next five years has also jumped to 1.49 percent, from 1.07 percent a month ago, data compiled by Bloomberg show.
Even if rates do rise, there’s are plenty of reasons to own Treasuries, according to Jennifer Vail, U.S. Bank Wealth Management’s head of fixed-income research. Treasuries will remain the haven of choice as Europe faces a bout of deflation, Japan is mired in another recession and growth weakens in China.
Negative yields in Germany and Switzerland, as well as the dollar’s strength, also mean the U.S. is still an attractive destination for overseas investors. Thirty-year Treasuries yielded 1.57 percentage points more than comparable German debt at the end of last week, the most since at least 1994.
“The drivers are all putting downward pressure on yields, so we do like Treasuries,” Vail said from Minneapolis. “Most of that pressure is from the global hunt for safety and yield.”

Yield Forecasts

Recent history hasn’t been kind to anyone calling for a tumble in bonds. Last year, Wall Street prognosticators said benchmark Treasury yields would rise and end at 3.44 percent last year. Instead, they fell to 2.17 percent.
So far this year, it’s been more of the same as selloff that forecasters predicted has yet to materialize.
While Treasuries may remain in demand for the time being, Eaton Vance Management’s Stewart Taylor is bracing for a sudden shift in sentiment that causes yields to jump.
“Perception changes on a dime,” Taylor, a money manager who helps oversee $296 billion globally, said from Boston. “I’m sitting on pins and needles every day.”