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Yield grab pushes U.S. Treasuries curve to flattest since 2007

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(Bloomberg) — A stronger U.S. consumer and yield-hungry foreign buyers are steamrolling the Treasury market’s yield curve.

Two-year Treasuries underperformed 10-year debt for a fifth day as traders re-evaluated bets on Federal Reserve policy tightening after the strongest readings on U.S. retail sales and consumer confidence in a year. The gap between two-and 10-year yields, known as the yield curve, flattened to the narrowest since 2007 on a closing basis.

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Buyers snapped up longer-term U.S. notes this week as negative yields on international government debt made Treasuries attractive in comparison. A class of institutional investors bought the biggest-ever share at an auction of 10-year notes, which sold at the lowest yield in more than three years. At the same time, short-term debt fell on speculation strong U.S. economic data will prompt the Fed to move more quickly than previously expected.

Benchmark 10-year yields fell five basis points, or 0.05 percentage point, to 1.7 percent as of 5 p.m. in New York, according to Bloomberg Bond Trader data. The 1.625 percent security due in May 2026 was at 99 10/32.

Two-year yields fell about one basis point to 0.75 percent, leaving the gap between two-and 10-year yields at 95 basis points.

‘Steepener’ deferred

The trend has confounded strategists at banks such as RBS Securities Inc., one of 23 primary dealers that trade with the Fed. A team of analysts closed out a recommendation to bet on a steepening curve, which occurs when long-term yields rise more quickly than short-term yields, in a Thursday note.

Insurers generally prefer to use investments in higher-paying corporate bonds to support products with long-term obligations, such as long-term care insurance (LTCI) and long-term disability (LTD) insurance, but they hold some Treasuries, and the same factors shaping the Treasury market could make longer-duration corporate bonds less attractive. 

Some insurers and reinsurers have been hoping to cope with low bond yields by buying longer-duration bonds with higher returns.

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The analysts expected a steeper curve after the Fed’s March meeting, when it lowered forecasts for 2016 rate increases, since the policy statement prompted traders to anticipate officials will let inflation quicken. That would erode the value of long-term debt most. Yet securities maturing in 10 years or longer have returned 2.4 percent since that meeting, while short-term notes have gained 0.3 percent, according to Bloomberg index data. That’s because long-term debt prices have been supported by investors searching for yield, the RBS strategists wrote.

“We’ve got a large wall of money from investors who need to hit a nominal yield target,” Blake Gwinn, a U.S. rates strategist with RBS Securities, said in an interview. “As the market rallies, they need to reach farther out the curve to meet those targets.” The market “hasn’t really behaved in the way we would have envisioned,” Gwinn said.

Strong consumer

Japanese investors bought a record amount of foreign sovereign debt in March, and probably favored Treasuries, according to strategists at TD Securities (USA) LLC, a primary dealer. While the purchases have slowed, the strategists expect they will pick up again in coming months.

“There’s just a demand for yield,” said Priya Misra, head of global interest-rates strategy in New York at TD Securities. Misra is forecasting the Fed will next raise rates in September and again in March.

Futures traders are assigning a 52 percent chance of a Fed increase by the end of 2016, down from 93 percent at the end of last year.

Commerce Department data showed retail sales advanced 1.3 percent in April from the month before, more than the 0.8 percent forecast in a Bloomberg survey of economists. The University of Michigan’s preliminary reading of consumer sentiment rose to 95.8 in May.

“There’s no doubt it was a blowout, and the front end of the curve is taking it on the chin,” said David Keeble, New York-based head of fixed-income strategy at Credit Agricole SA. “It does make July much, much more likely” for a Fed move, “if we can keep this pace up.” 

See also: 

Low rates squeeze disability insurers

Slow bleed from low bond yields drains insurers’ returns


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