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U.S. bond market faces possible reckoning
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U.S. bond market faces possible reckoning

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U.S. bond market faces possible reckoning

The rally in U.S. Treasury bonds surprised many, taking 10-year yields to their lowest levels in 11 months. Jobs data and the European Central Bank meeting next week will determine whether bond prices have further to go.

The bond market's rally is the result of a confluence of factors - falling yields in Europe, extra demand from pension funds, concerns among investors about long-term economic demand and technical factors, including short-covering from those who thought bond yields were headed higher.

Prices have jumped, pushing the yield on benchmark 10-year U.S. Treasuries Thursday to 2.422 percent, the lowest since last June, despite the U.S. Federal Reserve's easing back on its bond-buying stimulus program.

Investors aren't convinced that the Fed is cutting stimulus because of an impending surge in growth. Instead, they're more worried about weak economic indicators and a lack of inflation, which could change in the case of a strong jobs report or data showing price gains.

Since it's far from certain how the jobs data will come in or how forcefully the ECB will act, the bond market is likely to remain on edge.

David Keeble, global head of interest rates strategy at Credit Agricole Corporate and Investment Bank in New York, said a decent jobs report could "remind us that we have to get back to the reality that the economy is picking up."

Employers are expected to have added 215,000 workers in May, according to a Reuters poll, following an increase of 288,000 in April, which was the biggest gain since January 2012.

While the labor market continues to heal, it has not been enough to jump-start wages, the most potent factor in kindling inflation concerns.

"The key is wages moving higher and inflationary expectations starting to move higher," said Quincy Krosby, market strategist at Prudential Financial, based in Newark, New Jersey.

Expectations that the ECB will announce more aggressive action next Thursday to boost the euro-zone economy have also helped drive U.S. and European bond yields down to levels not seen in a year. Benchmarks in Italy and Spain have dropped dramatically, making U.S. rates look attractive by comparison.

Part of the drop in yields stems from investors trying to exit earlier bets on rising yields. Some bond fund managers were stung by a bet on lower five-year note yields and higher 10-year yields, a strategy favored by many hedge funds heading into the year.

"These positions have underperformed so far this year as the yield curve has flattened and bond yields have fallen," Wells Fargo analysts wrote in a note.

The bond market's price gains could be far from over, given recent history.

But if the market's direction reverses and yields move higher, they could do so in rapid fashion.

"It's like playing a game of Russian roulette with the bond markets right now," Keeble said. "You know something is going to go 'bang,' and you just don't know when."

U.S. bond market faces possible reckoning | Reuters

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