As the U.S. bond market suffers its worst rout since 2009, the gauge that historically signals more pain for fixed-income investors is instead suggesting yields are near their peak.
The gap between two- and 10-year Treasury yields widened to 2.55 percentage points this month, double the median of 1.23 points since 1990 and approaching the record 2.93 points in February 2010, data compiled by Bloomberg show. The yield curve is steepening at the fastest pace since 2009 as the Federal Reserve signals its intent to keep the target interest rate for overnight loans between banks at about zero into 2015 while reducing the bond-buying economic stimulus that drove 10-year yields to the highest level in more than two years.
While the yield curve typically steepens when faster growth leads investors to demand more insulation from inflation, bond strategists say this time is different. After rising from this year’s low of 1.61 percent on May 1 to 2.93 percent last week, the increase in 10-year yields will slow, with rates reaching 3.05 percent in the second quarter of next year, according to 63 economists in a Bloomberg News survey. Losses will be limited by an economy growing at half the post-World War II average and an inflation rate below the Fed’s 2 percent target, they say.
“I don’t think the steepness of the curve is reflective of very bullish expectations for growth or great concern for inflation,” Wan-Chong Kung, who helps oversee more than $100 billion as a fund manager at Nuveen Asset Management in Minneapolis, said in an Aug. 21 telephone interview. “It’s an artifact of the very accommodative monetary policy we continue to operate under.”
When the yield curve reached its record in February 2010, investors pushed the 10-year rate to 3.77 percent after the Fed restated its intention to withdrawal extraordinary stimulus measures as the economy strengthened.
The widest gap before the 2007 financial crisis was 2.86 percent in August 2003 as the Fed held its overnight rate at a then-record 1 percent while the economy lost jobs amid sluggish growth. The average spread in the 1980s was 0.48 percentage point, 0.88 percentage point in the 1990s and 1.06 percentage points from 2000 through 2008.
This year’s losses on Treasuries––the Bloomberg U.S. Treasury Bond Index is down 3.6 percent––will reverse by mid-2014 if the analyst survey proves correct. An investor buying $10 million of 10-year notes will earn about $160,000 after accounting for interest payments by June 30 even if yields rise to 3 percent.
Fed Chairman Ben S. Bernanke has said the central bank will keep its overnight lending rate at zero to 0.25 percent into 2015. That’s anchoring two-year note yields, which in turn restrain 10-year securities.