What Fed increase? Top Treasuries forecaster is bullish for 2016

(Bloomberg) — The most-accurate forecaster of the $13.1 trillion Treasuries market this year says the Federal Reserve is too optimistic in its plan for additional interest rate increases after Wednesday’s expected liftoff, and that’s good news for bonds.

Guy LeBas, chief fixed-income strategist at Janney Montgomery Scott LLC, an investment adviser in Philadelphia, expects 10-year yields to end 2016 at 2.22 percent, not far from their 2.27 percent level at 7:44 a.m. in New York Wednesday. He joins the slim ranks of contrarian voices — the median forecast in a Bloomberg survey is 2.78 percent.

Investors have reason to heed LeBas’s advice. He’s proving the most prescient of 70 participants in a December 2014 Bloomberg survey. His forecast for a 2.47 percent 10-year yield at the end of this month was the poll’s lowest, and it compared with the median estimate of 3.01 percent. He was also the only one projecting 30-year yields below 3 percent at year-end 2015, based on the view that inflation will remain below the Fed’s target. The long bond yielded about 3 percent Wednesday.

When LeBas became more bullish in January, revising his yield forecast lower, he said one money manager told him the scenario was “not worth thinking about.” Yet he’s sticking to his guns for 2016, anticipating that tame inflation and tepid economic growth will limit the Fed to two rate increases next year, while policy makers’ forecasts indicate four moves.

“What the bond market is still getting wrong is too much certainty over inflation,” said LeBas, a 34-year-old New Jersey native. “Investors should buy 10- and 30-year Treasuries. The returns will be acceptable, but not spectacular.”

Bears beware

Treasuries are defying forecasters’ bearish calls for the second straight year. Ten-year yields are the lowest leading into a tightening cycle since at least the 1960s, data compiled by Bloomberg show. Yields have been capped in 2015 as global central banks added stimulus, while China’s cooling economy and plunging commodities damped inflation.

Treasuries have earned 1 percent this year after returning 6.2 percent in 2014, according to data compiled by Bloomberg. U.S. government debt is poised for annual gains even as the Fed may boost rates for the first time since 2006 and keep lifting them next year.

LeBas has a history of being more bullish on Treasuries than the consensus. In three of the past five years, he correctly called for lower 10-year yields than the median forecast in year-end Bloomberg surveys. He wasn’t included in the 2012 poll, and at the end of 2013 he was more bearish than the consensus. Treasuries wound up rallying in 2014.

Strategy shaper

His year-end 2016 prediction for 10-year yields is far from the most bullish. Four of the 60 contributors to this month’s Bloomberg survey have lower forecasts: Intesa Sanpaolo SpA, Kennesaw State University, Standard Chartered Plc and Stifel Nicolaus & Co.

“We have followed Guy for a few years and his views have been helpful in shaping our investment strategy, and specifically the idea that rates were going to remain at low levels for a long period of time,” said Ryan McQuilkin, a money manager at Boston Private Wealth LLC, which oversees $8 billion.

Oil’s role

Fed officials have signaled a gradual pace of increases after liftoff. Their median estimate for the Fed target at the end of 2016 was 1.375 percent in September, suggesting the potential for four quarter-percentage-point increases next year.

Trading in swaps indicates the fed funds effective rate will fall short of that, averaging 0.75 percent in a year and 1.26 percent in two years, according to data compiled by Bloomberg. While the central bank sees its benchmark reaching 3.5 percent in the next tightening cycle, LeBas predicts it will peak at 2 percent.

This week’s tumble in crude oil prices to the lowest since 2009 has made LeBas even more bullish on bonds by capping inflation. He predicts 30-year Treasury yields will end 2016 at 2.86 percent, while the median projection is for 3.38 percent.

“There’s something in between bull and bear and that’s where we’ll be for interest rates,” LeBas said. “I like to call it the hamster market — we’re running around in a wheel, but going nowhere fast.”