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March 16, 2012 at 09:52 AM
The U.S. bond market outside of Treasuries is shrinking, and the lack of growth could very well reduce interest rate risk while benefiting some market sectors with attractive bond valuations and higher yields, according to Anthony Valeri, LPL Financial’s market strategist, in a report published this week.
Valeri predicted that the 2012 bond market will see only “negligible” growth, in a repeat of 2011.
“We believe the bond market will exhibit negligible growth in 2012 in a near repeat of 2011,” Valeri wrote in a note published Tuesday, The Incredible Shrinking Bond Market. “Consensus forecasts call for MBS, agency and commercial paper markets to continue to shrink in 2011, municipal bond market growth to be flat, and corporate bond market growth to be modest again.”
Fed policy, economic growth and inflation expectation are the primary drivers of bond yields, but supply and demand factors are also relevant for bond investors because they can have a secondary impact on bond market yields and valuations, he noted.
“When it comes to debt market supply, steady Treasury issuance garners most of the headlines. A closer look at the broader bond market, however, reveals that the bond market is exhibiting virtually no growth, and after taking into account Federal Reserve purchases, the bond market is actually shrinking,” Valeri wrote.
He pointed to the Fed’s quarterly flow of funds data as of Dec. 31 in making his argument, which shows that the broad U.S. bond market saw almost no growth in 2011, expanding by “a paltry” 1%.
