By Liz Capo McCormick and Anchalee Worrachate
Aug. 31 (Bloomberg) -- The bond market isn’t buying all the optimism over the end of the global recession.
While the International Monetary Fund said last week the economic recovery will be faster than it forecast in July, investors pushed yields on government debt to the lowest level since April, according to the Merrill Lynch & Co. Global Sovereign Broad Market Plus Index. The gauge, which tracks $15.4 trillion of bonds worldwide, gained 0.73 percent this month, the most since 1.02 percent in March.
Debt investors can’t see a recovery strong enough to spur central bank interest rates anytime soon, especially with the Obama administration forecasting that unemployment in the U.S. - - the world’s largest economy -- will rise above 10 percent in the first quarter. After stripping out the effects of the U.S. government’s “cash for clunkers” program to buy new cars, consumer spending was unchanged in July, according to Commerce Department data released on Aug. 28.
“The bond market does not believe we will see rapid robust rates of growth,” said Jeffrey Caughron, an associate partner in Oklahoma City at The Baker Group Ltd., which advises community banks investing $20 billion. “The deleveraging of the consumer will act as a drag on growth, which will keep inflation to a minimum and interest rates relatively low.”
‘Bumpy Road’
Bond yields are lower now than when Federal Reserve Chairman Ben S. Bernanke said in an Aug. 21 speech at the Kansas City Fed’s annual symposium in Jackson Hole, Wyoming, that “prospects for a return to growth in the near term appear good.” European Central Bank President Jean-Claude Trichet said that while the economy is no longer in “freefall,” it faces “a very bumpy road ahead.”
Two-year Treasury note yields fell 7 basis points, or 0.07 percentage point, last week to 1.02 percent, and are down from this month’s high of 1.36 percent on Aug. 7, according to BGCantor Market Data. The 1 percent security maturing on August 2011, sold by the government Aug. 25, ended the week at 99 31/32.
The two-year note yielded 1.01 percent as of 11:06 a.m. today in Tokyo.
The picture is the same in Europe. U.K. two-year gilt yields dropped to a record low of 0.828 percent on Aug. 27 before ending the week at 0.84 percent. German bund yields of similar maturity declined 12 basis points to 1.25 percent last week and fell from 1.61 percent on Aug. 10 even as government reports showed the economy exited the recession in the three months ended June 30.
Making Money
Yields on government bonds of all maturities average 2.27 percent, compared with this year’s peak of 2.62 percent on June 8, according to the Merrill Lynch index. The drop helped return fixed-income investors to profit, earning 2.14 percent since the start of June after losing 1.54 percent in the first five months of the year.
Fixed-income strategists at London-based HSBC Holdings Plc said the drop in yields reflects a growing perception that central banks are unlikely to raise borrowing costs as soon as forecast just a month ago.
“Interest rates are likely to remain at record lows for quite a while,” said Andre de Silva, the deputy global head of fixed-income strategy at HSBC, Europe’s largest bank.
Rate Odds
Traders are pricing in less than a 50 percent chance of a U.S. rate increase before March, federal funds futures show. As recently as June, they saw 70 percent odds of a boost in the Fed’s target rate for overnight loans between banks to at least 0.5 percent in November from the current target range of zero to 0.25 percent.
In Europe, traders are paring bets the ECB will raise its main refinancing rate from 1 percent this year. The implied rate on the Euribor futures contract expiring in December was 0.85 percent on Aug. 28, down from 1.22 percent at the start of June.
Bond investors are more pessimistic than stock investors, who have pushed the MSCI’s World Stock Index to the highest level since October.
The index rallied 4.7 percent this month after the Washington-based IMF, which rescued countries from Iceland to Pakistan during the global crisis, said in July the world economy will expand 2.5 percent in 2010 following a 1.4 percent contraction this year. Since then, Japan, France and Germany returned to growth.
Recovery in Sight
“We do believe the recovery is in sight and is going to be perhaps a little better than we had at one time thought, but we expect a rather muted recovery,” Caroline Atkinson, the IMF’s external relations director, said to reporters in Washington on Aug. 27.
Reports last week in the U.S. and Europe showed home sales, durable goods orders and business sentiment rose more than forecast. The median estimate of 55 economists surveyed by Bloomberg is for growth in the U.S. of 2.3 percent next year.
“It’s too pessimistic a view to look at all these factors and still think we won’t have a reasonable recovery,” said Michiel de Bruin, who helps manage $27 billion as head of European government debt in Amsterdam at F&C Asset Management Plc’s Dutch unit. “Our view is that if unemployment rises at a slower pace than expected, that’s already good news. Against this backdrop, government bonds will find it very hard to sustain a rally going forward.”
Two-year Treasury yields are forecast to end the year at 1.32 percent, while 10-year yields may rise to 3.87 percent from 3.45 percent last week, according to the median estimate of more than 45 economists and strategists surveyed by Bloomberg.
An increase to those levels would still leave 10-year yields below their average of 5.63 percent during the past 20 years.
Relatively Low
Treasuries gained last week even as reports showed the housing market may have bottomed. Although the National Association of Realtors in Washington said Aug. 21 that sales of existing U.S. home jumped 7.2 percent in July to the highest level in two years, prices fell 15 percent from a year earlier.
“Evidence has been accumulating that housing has begun to put in a bottom,” said Jay Mueller, a senior money manager who oversees about $3 billion of bonds at Wells Fargo Capital Management in Milwaukee. “Still, the news isn’t that earth shaking. Going forward we are going to need to see a lot more fundamental justification on the economy getter better, and not just less bad information, if the move to riskier assets is to be sustainable.”
Mutual Funds
Mutual funds, pensions and endowments sold $1.79 billion more shares of companies that rely on consumer spending this month than they’ve bought, the fastest pace in at least 14 years, based on data compiled by Boston-based State Street Corp., the custodian of $16.4 billion of assets.
The world’s biggest financial institutions, which have taken $1.6 trillion in writedowns and losses since the start of 2007, are scooping up bonds at an accelerating pace.
Bank holdings of government securities and debt of mortgage companies Fannie Mae in Washington and McLean, Virginia-based Freddie Mac increased to a record $1.37 trillion in the week ended Aug. 12, from $1.31 trillion on July 29, Fed data show. The 4.8 percent jump was the biggest for any two-week period since the start of the year.
The surge comes as the U.S. savings rate reached 6.9 percent in May, the highest level since 1993. It was as low as zero as recently as April 2008.
The bond market is signaling that the measures by policy makers may not be enough because unemployment is forecast to climb, capping consumer demand, which accounts for about 70 percent of U.S. economic activity.
‘Not Convinced’
“It’s not at all clear that the economy is out of the woods yet,” said Mihir Worah, who invests the $14 billion Real Return Fund for Newport Beach, California Pacific Investment Management Co. “We still have to see convincing signs that the consumer can survive once the government stimulus is taken away, and we are not convinced of that.”
The last time the U.S. unemployment rate was above 10 percent was in 1983, following the recession of 1981 and 1982. Cuts in the Fed’s target rate from 20 percent at the start of that contraction to 8.5 percent, combined with deficit spending by the Reagan administration helped push the jobless rate down to 7 percent by the end of 1985.
At the start of this recession in December 2007, the Fed’s target rate for overnight loans between banks was 5.25 percent, driving policy makers to alternative measures such as purchases of bonds after it cut borrowing costs to almost zero in December.
Wage Drop
Wages and salaries fell 4.7 percent in the 12 months through June, the biggest drop since records began in 1960, Commerce Department figures show. Purchases will probably climb at an average 1.6 percent quarterly rate through June 2010, compared with 2.8 percent during the six-year expansion that ended in December 2007, according to a Bloomberg survey of economists this month.
Threadneedle Asset Management Ltd. in London, was bearish on Treasuries until May.
“There’s much optimism about the state of the economy in general,” said Dave Chappell, a money manager at the company, which oversees $90 billion. “But when the stimulus programs, such as a credit tax break for first-time home buyers, run off, can the momentum continue? It probably can’t. Treasuries, particularly long-dated ones, are unlikely to buckle with this improving view on the economy.”
To contact the reporter on this story: Liz Capo McCormick in New York at emccormick7@bloomberg.net; Anchalee Worrachate in London at aworrachate@bloomberg.net.
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