Bond yields were supposed to rise this year. A Bloomberg survey of economists found the average forecasts for US 10-year yields at the end of March was 4.31 per cent, with 5 per cent the end-year target. Instead the 10-year yield was hovering around 4 per cent on Thursday while two-year eurozone yields fell to their lowest levels in recent history.
The main problem seems to be that many investors began the year with bearish bond positions (just as they were negative on the US dollar). A JP Morgan survey found that both international and domestic investors were short the US bond market. As bond prices have strengthened (and yields have fallen), such investors have had to cover their short positions.
Tim Bond of Barclays Capital says that “at the start of the year, many bond funds had accumulated a lot of cash and we are seeing some capitulation buying.” The long end of the market is also being boosted, according to Bond, by the sale of structured products known as constant maturity swaps, which require banks to buy bonds as a hedging strategy. And there has also been buying in anticipation of a change in the rules governing US defined benefit pension funds, which is expected to encourage funds to have a higher bond weighting.
Add in the purchasing of US bonds by Asian central banks, part of their strategy to keep their currencies from rising against the dollar, and the use of the carry trade (borrowing at short rates and investing in higher-yielding assets) by speculative investors and there is a lot of demand for bonds.
All this is keeping bond yields low, even though many commentators feel yields of 4 per cent are insufficient to compensate investors for the risks of higher inflation or further issuance prompted by budget deficits.
Two recent factors may also have helped the bond markets. First, Atlanta Federal Reserve president Jack Guynn signalled that the Fed may drop its reference to “measured” interest rates increases. Some interpreted the statement as suggesting US short rates were near their peak. Second, North Korea’s announcement about nuclear weapons may have encouraged some safe haven buying of government bonds. When the demand is there, almost any piece of news is an excuse to buy.