For all the talk that U.S. Treasuries will tumble once the Federal Reserve starts to raise interest rates, investors in the longest-dated debt securities are finding little cause for concern.
Government bonds due in 30 years, the most vulnerable to losses when growth picks up and inflation accelerates, have returned more than 20 percent this year versus 2.9 percent for five-year Treasuries. That’s reduced the yield premium that investors demand to hold the 30-year securities to 1.46 percentage points, close to the lowest since 2009.
Even as the U.S. economy shows signs of gaining momentum, buyers are pouring into long bonds because the collapse of inflation expectations suggests long-term growth will moderate as Fed Chair Janet Yellen lifts borrowing costs from close to zero. The five-year inflation outlook starting in 2019 has fallen a half-percentage point this year and reached a three- year low of 2.14 percent last month, based on a bond metric known as the five-year, five-year forward break-even rate.
“The tenet is still in place for the long end to do better,” Wilmer Stith, a Baltimore-based fund manager at Wilmington Trust, which oversees $82 billion, said by telephone on Nov. 7. “The drumbeat of Fed returning to a normalization of monetary policy is growing louder. Inflation is very well maintained below” the Fed’s own 2 percent target.
Stith said the firm is buying 30-year Treasuries as part of a “barbell” strategy that includes adding one-year debt and selling notes due in 3 years to 5 years, which he said stand to bear the brunt of losses as rates increase.
Stagnant Wages
Longer-term Treasuries rallied after last week’s employment report bolstered the view that stagnant wage growth is keeping price pressures in check as the world’s largest economy adds the most jobs in 15 years. Average hourly earnings rose 0.1 percent from the prior month, half the increase economists projected, the Labor Department report showed. It was the fifth time this year that wages either increased 0.1 percent or were unchanged.
Yields on 30-year bonds ended at 3.03 percent last week, about 0.1 percentage point from the lowest closing level in a year and almost a full percentage point below where they were at the start of 2014. At that time, almost everyone predicted yields on Treasuries of all maturities would increase as the Fed’s bond buying program bolstered a rebound in the U.S. economy, spurred faster inflation and put the central bank on track to end its near-zero rate policy.
While the strongest six months of U.S. economic growth in a decade has futures traders pricing in the prospect the Fed will raise rates within a year, lackluster wage gains, weaker growth abroad and slumping energy prices caused investors to trim their expectations for how much consumer prices can rise.
‘Inflation Genie’
With the Fed’s preferred gauge of inflation falling short of its target for 29 straight months, bond yields now imply consumer prices in the five-year span starting November 2019 will rise an average of 2.17 percent per year.
In the five years before the crisis, living costs measured by the U.S. consumer price index rose almost 3 percent on average. The bond market’s inflation outlook in the next three decades is even lower, falling to 2.1 percent annually. The quarter percentage-point drop this year is the most since 2011.