US 10-year Treasury yields looked set to close below 4 per cent this week even as investors prepared for the Federal Reserve to raise short-term interest rates again next week.
At the same time, the yield on the German 10-year Bund fell as low as 3.105 per cent on Friday, its lowest since Bundesbank records began in 1973. The Fed’s meeting, which concludes on June 30, will mark a full year of the central bank’s policy of a steady, quarter-point rate rise at each meeting. The market expects the benchmark Federal funds target, currently at 3 per cent, to be raised to 3.25 per cent at this meeting.
By late morning in New York on Friday, the 10-year yielded 3.93 per cent, down 2.7 basis points on the day, and 77bp lower than this time last year. Typically, as short-term interest rates rise in response to inflation pressures, longer-dated bond yields rise to price in greater uncertainty.
The divergence this time has been described as a “conundrum” and observers have been at pains to construct coherent theories for why it has happened.
But David Rosenberg, chief US economist at Merrill Lynch says yields at these levels are hardly such a conundrum if one takes a starting point of June 2003, when the 10-year touched a low of 3.1 per cent as investors worried about the spectre of deflation. From then until 2004, yields rose as investors prepared for the eventual rise in short term rates. “The 10-year is merely in the mid-point of the range since that time,” he said in a research note.
Oil prices this week provided further impetus to bond bulls as investors focused on the damping impact high energy costs will have on growth, rather than the potential upwards stimulus to inflation – a bond negative. Equities weakened as crude gained, supporting the rise in bond prices.
The low level of yields encouraged corporate borrowers into the market this week, and new issuance of high-grade debt reached its second highest level this year, according to data from Thomson Financial.
Led by a $4bn offering from Residential Capital, the residential mortgage arm of General Motors, and $3bn in five-year paper from Goldman Sachs, borrowers tapped the market for a combined $21.5bn, almost double the amount sold the previous week.
