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Treasury Yields Falter at 2% Hurdle as Sell-Off Runs Out of Road

Liz Capo McCormick and Sid Verma

(Bloomberg) -- A 2% yield on benchmark Treasuries, which seemed imminent a week ago as the bond market was sliding, is suddenly looking far off.

The headwind to global growth from the the U.S.-China trade war persists, keeping investors happy to hide out in debt markets. The case for fresh downside in U.S. and European sovereign yields has also gained muster from disappointing data, including tepid U.S. inflation and weak growth in Asia’s biggest economies.

“Our low-for-longer view remains in place,” HSBC Holdings Plc fixed-income strategist Steven Major wrote in a note with his colleagues. They predict the U.S. 10-year yield will end the year at 1.5%. “The uncertainty on the trade outlook means yields may consolidate before they fall again.”

After a wild ride this month, with 10-year yields touching a three-month high of 1.97% on Nov. 7, uncertainty is back on the menu. Some investors and options traders are refraining from taking big wagers, and HSBC’s Major sees Treasury yields finishing 2020 at 1.5% as well.

HSBC’s rationale is driven by stubbornly low inflation emboldening the case for low interest rates. The bank concludes the Federal Reserve’s policy stance is currently neutral rather than accommodative, citing a model comparing economic momentum with the cost of short-term debt.

The yield on 10-year Treasuries fell as much as eight basis points Thursday to 1.8%, and is down about 12 basis points this week. German bund yields fell five basis points to -0.355%, while equivalent U.K. yields dropped five basis points to 0.71%.

This week’s decline in yields came after President Donald Trump doused prospects for the U.S. and China to roll back tariffs anytime soon. Cooling U.S. core inflation and comments from Fed Chairman Jerome Powell this week haven’t altered the outlook for stable policy rates, adding to the downside in yield momentum.

Fresh fuel for the bond market’s somber outlook came Thursday as data from Asia showed weakness. Even Germany dodging a recession wasn’t great news for bond bears as it dampened speculation that the government will add fiscal stimulus.

Ten-year Treasury yields “will struggle to move sustainably above 2.2%” because a resurgence of inflation is needed to trigger a sustained rise, and that’s not likely, Praveen Korapaty, chief global rates strategist at Goldman Sachs Group Inc., said in a note this week. Even if there are signs of economic green shoots and a rollback in tariffs, the “major portion of the bond market sell-off is behind us,” he said.

U.S. volatility markets are also showing a lack of confidence in the global bond reflation trade. The signals from options pricing highlight the lack of conviction on whether yields will break out in either direction, pointing to broader ranges being maintained for now. One-year options on 10-year interest rate swaps imply a 68% chance the 10-year Treasury yield will range between 1.2% and 2.5% over the next year.

Moving Neutral

Zhiwei Ren, a portfolio manager at Penn Mutual Asset Management, has gone “neutral duration” in Treasuries. He expects the 10-year yield to move between 1.5% to 2.25% over the next six to 12 months.

There are things on the radar that support the prospect for higher yields.

Global factory gauges are among data starting to brighten, signaling that the the world economy could be edging into stabilization mode. This comes as many economists see the high water mark on developed central banks’ dovishness as potentially in the rear view mirror. Meanwhile, Treasury term premiums rose this month to the highest since July and are seen on course to rise further.

Still, JPMorgan Asset Management, in its 10-to-15-year outlook, forecasts global growth will average just 2.3%, with inflation remaining tepid and paltry returns on government bonds.

And just because bond yields are historically low doesn’t mean they can’t fall even further, Karen Ward, JPMorgan Asset’s chief market strategist for EMEA, said this week. She pointed to Austria’s sale this year of 100-year bonds at what then seemed an incredibly low yield of 1.171%. It has since fallen to about 0.95%.

“Something 2019 has particularly taught us is that even if something seems low by historical standards –- we can see new lows,” Ward said.

To contact the reporters on this story: Liz Capo McCormick in london at emccormick7@bloomberg.net;Sid Verma in London at sverma100@bloomberg.net

To contact the editors responsible for this story: Paul Dobson at pdobson2@bloomberg.net, Neil Chatterjee, Mark Tannenbaum

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