The Highest-Yielding Treasury Bond Isn't Declining Like Its Peers

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A recent climb in the yield on the benchmark 10-year U.S. Treasury note has prompted some investors to declare an end to a more-than-three-decade bull market in bonds. But the longest-dated Treasurys suggest those calls may be premature.

While the yield on the benchmark 10-year note has closed as high as 2.663% this year, breaking through its 2017 peak, the 30-year yield closed Friday at 2.911% -- still well below its 2017 high of 3.194%.

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Many investors say that the climb in the 10-year yield, which rises as bond prices fall, reflects bets that recent tax cuts will increase the pace of growth and inflation, prompting the Federal Reserve to raise interest rates and denting the value of outstanding government debt. But other analysts say the continuing strength in the 30-year bond suggests that the longer-term outlook may not be quite so rosy.

Since September, when Fed officials released a plan for reducing the central bank's bondholdings and restated their commitment to raising rates in coming years, the gap between the two yields has been cut in half, to 0.25 percentage point Friday, the smallest since the financial crisis. Some investors and economists said that is a sign buyers of 30-year Treasurys aren't convinced that a prolonged surge in growth and inflation lies ahead.

One reason for concern about the expansion is the Fed.

Fed officials in December signaled their intention to raise interest rates three times this year and twice more in 2019, after lifting borrowing costs four times since December 2016. Some investors and analysts expect that continuing to raise interest rates -- even as inflation has yet to hold at the central bank's 2% target -- should contain price pressures and keep down longer-term bond yields.

Even with unemployment at 17-year lows and the 2017 tax overhaul leading some companies to raise salaries or offer one-time bonuses, "there's really no fear of inflation," said Charles Comiskey, head of Treasury trading at the Bank of Nova Scotia. Inflation poses a threat to the value of long-term government bonds because it erodes the purchasing power of their fixed payments.

Surging stocks are also contributing to demand for 30-year bonds as investors such as pension funds have been paring some holdings and moving into bonds to lock in gains, creating "consistent demand for that part of the market," Mr. Memani said.

Other demand comes from investors making paired bets that longer-term Treasury yields will decline relative to the yields on short-term debt, which are expected to continue to rise as the Fed raises rates. These bets are profitable as the gap between different bond maturities narrows, a trend known as a flattening yield curve.

While the tax cuts are expected to boost growth this year, some economists expect most of the benefits to accrue in its first year or two. Steady demand for 30-year Treasurys could reflect the view that stimulus to growth and inflation from the tax-code changes will soon peter out.

"The impact of the tax cuts will fade, perhaps as soon as the first quarter" of 2018, said David Rosenberg, chief economist at Gluskin Sheff + Associates. "It could well be that people who are buying long bonds are taking a more long-term view."

The demand for 30-year Treasurys contrasts with the view of Bill Gross, who gained renown as manager of the Pimco Total Return Bond Fund, once the world's largest fixed-income portfolio. He recently said investors were facing a "bond bear market."

Several investors said analysts have predicted the end of the long bull market in recent years, only to watch bonds rally again. Some cited two factors testing the bond market's durability in coming months: the Fed's decision to pare its $4.2 trillion in bondholdings and inflation.

The balance sheet reduction will have an effect equivalent to raising interest rates by an additional percentage point, possibly weighing on growth and inflation, Mr. Rosenberg said.

The bond market's expectations for the inflation rate over the next 10 years have been rising, with a key gauge in January surging above 2% for the first time since March. Yet 30 years out, the market's forecast is 2.1%, suggesting minimal concern that consumer prices will soar in the long-term.

That shouldn't be surprising after years of very soft inflation, said John Bellows, a bond fund manager at Western Asset Management, who has taken positions benefiting from a flatter yield curve.

"It's a long way from the bond market having reprice inflation risk," he said.

Write to Daniel Kruger at Daniel.Kruger@wsj.com

(END) Dow Jones Newswires

January 29, 2018 08:14 ET (13:14 GMT)

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