Gundlach: Betting against Treasuries is a fool's game

A growing number of portfolio managers are re-evaluating their forecasts for rising yields

Feb 3, 2014 @ 1:05 pm

Jason Brady avoided 10-year Treasury notes as yields fell to all-time lows and a soaring stock market slowly sapped demand for government debt. No more.

Even though the Federal Reserve is cutting the amount of bonds it buys as the economy improves, the managing director at Thornburg Investment Management, which oversees $95 billion, said he recently scooped up the securities as yields approached a two-year high of 3%.

“With the exuberance around risk assets that we saw toward the end of last year, which had every single strategist deciding that stocks were the best thing in the world and bonds were the worst thing in the world and that rates were certainly going higher and anybody who was otherwise is crazy — that started to be a little much,” Mr. Brady said.

A growing number of investors are thinking the same thing. The performance of Treasuries is confounding forecasters, who predicted a second consecutive year of losses, by getting off to their best annual start since 2008, returning 1.6% in January as measured by Bank of America Merrill Lynch index data. Sluggish employment growth, emerging-markets turmoil triggered in part by the Fed's reductions in monetary stimulus and a shrinking supply of U.S. debt — thanks to a smaller budget deficit — has investors re-evaluating forecasts for higher yields.


The market was “entering 2014 struck by a greater consensus entering any year that I can remember, that the dollar has to do well, gold is for losers and bond yields will rise,” said Jeffrey Gundlach, chief executive officer of DoubleLine Capital, which manages $49 billion. “Things were so lopsided in terms of that positioning. That was late in that way of thinking.”

The amount of bets against 10-year Treasuries by hedge funds and other large speculators shrunk to as low as 58,000 contracts last month from a 19-month high of about 189,000 in November, data from the Commodities Futures Trading Association show.

Mr. Gundlach predicts yields will fall in 2014, with demand rising from investors such as banks seeking high-quality collateral to meet new regulatory requirements and as a haven for others from political and economic turbulence in nations ranging from Turkey to Argentina. Mr. Gundlach outlined his views for investors in a conference call Jan. 14.

Treasury 10-year yields dropped to 2.64% on Jan. 31 from 3.03% at the end of 2013, in the biggest one-month decline since August 2011. That's when markets were thrown into disarray as Standard & Poor's stripped the U.S. of its AAA credit rating, prompting investors to seek a haven in Treasuries.

Benchmark yields fell 7 basis points last week, Bloomberg Bond Trader data show, touching a more than two-month low. The benchmark 2.75% note due in November 2023 rose 19/32 or $5.94 per $1,000 face amount, to 100 28/32. The yields dropped 38 basis points on the month.

Yields erased earlier gains Monday after the Institute for Supply Management's manufacturing index declined to 51.3, from 56.5 in December, compared with the median forecast in a Bloomberg survey for a decline to 56. Readings above 50 indicate expansion. Yields touched 2.61%, the lowest since Nov. 8, before declining two basis points to 2.63% in Monday trading .


Strategists and economists have largely stopped boosting their estimates for how high yields will get in 2014. The year-end, weighted-average forecast of 70 participants in a Bloomberg survey has been little changed at 3.42% since November, after increasing from 3.14% the prior four months.

“The possibility of 10-year yields moving a lot higher was predicated on an out-of-consensus economic scenario, and yet the consensus was for rates to move a lot higher,” said Thomas Graff, who manages $3.6 billion of fixed-income assets at Brown Advisory Inc.

Mr. Graff said he is favoring government debt over credit-related assets such as corporate bonds for the first time since 2009.

A Labor Department report released Jan. 10 showed the economy added 74,000 jobs in December, trailing the median forecast of 197,000 in a Bloomberg News survey of 90 economists. That was followed by a Jan. 28 Commerce Department report showing durable goods orders declined in December by the most in five months, dropping 4.3%. The National Association of Realtors said that contracts to buy previously owned homes in the U.S. plunged in December by the most since 2010.

Doubts about the strength of the economic recovery are being compounded by turmoil in emerging markets, with Treasuries benefiting from a flow of money that last month weakened currencies from Brazil to South Africa.

In China, a report from HSBC Holdings and Markit Economics showed that manufacturing contracted in January, raising concern about the growth outlook for a country that buys everything from Chile's copper to Brazil's iron ore.

To Thornburg's Mr. Brady, the outlook is so dire that Fed policy makers may need to reverse course and add more stimulus, benefiting bonds.

“Ultimately, they're going to feel like they need to do more,” he said. “A month ago everybody was like 'the U.S. economy is fabulous, everything's wonderful, this is awesome, we like everything.' Here we are one month later and everyone's all concerned.”

One long-time bond bull recently turned bearish, and he sees no reason to change course. Yields will reverse and end the year at 3.5% to 3.75% as the economy improves, according to David Rosenberg, the chief economist at Gluskin Sheff & Associates.

“The economy is on a moderate accelerating trend,” Mr. Rosenberg said. “We're coming out of a flight to quality on emerging markets. This is a blip rather than a long-term trend. The yield decline is temporary.”

Gross domestic product expanded an annualized 3.2% in the final three months of 2013, according to the Commerce Department on Jan. 30. That matched the median estimate of 72 economists in a Bloomberg News survey. GDP expanded 4.1% in the third quarter, the most in almost two years.

Even though U.S. yields have fallen, they're still higher relative to bonds from other major global economies, making them attractive on a relative basis.

The extra yield investors get for holding 10-year U.S. notes instead of similar maturity German bunds reached 1.11 percentage points on Jan. 22, the most since July 2006 based on closing prices.

“On a cross-market basis, Treasuries are by far the best market,” said Vimal Gor, who oversees A$15 billion ($13.1 billion) as the Sydney-based head of income and fixed interest at BT Investment Management Ltd. Mr. Gor said he's betting on gains in five-year U.S. Treasuries.

Bonds globally outperformed stocks, which reached record highs in 2013. Fixed-income assets returned 1.57% in January, the best start to a year since at least 1997, according to Bank of America Merrill Lynch index data. The MSCI All-Country World Index of stocks lost 4%.

Treasuries are also benefiting from a shrinking budget deficit after borrowing by the Obama administration to help pull the U.S. out of a recession led to shortfalls that exceeded $1 trillion for four straight years.

The government will sell $717 billion of notes and bonds on a net basis, 14% less than last year and the least since 2008, according to a survey last month of primary dealers which are obligated to bid at Treasury auctions. Higher corporate and individual tax receipts led the dealers to predict the budget deficit will decline to $629 billion, the least since 2008.


A potential fiscal showdown in Congress as lawmakers approach a deadline this week to increase the limit for the U.S. borrowing capacity may also temper any rise in Treasury yields.

There are “exogenous events and hiccups that could continue, as in the debt ceiling,” said Sean Simko, a money manager who oversees $8 billion at SEI Investments Co. “Investors remember what we just went through and uncertainty creates nervousness in the marketplace. It won't be a sharp and swift move higher — it will be a slow and gradual move” in yields.

Congress stoked market panic in 2011 and 2013 by delaying an agreement that fueled concern the U.S. could default. Standard & Poor's in 2011 stripped the U.S. of its top rating for the first time in 70 years amid congressional battles.

“We were a buyer at 3% — anything north of 3% is slightly long for us at this point,” James Camp, a money manager who oversees $5.5 billion in fixed-income assets at Eagle Asset Management said. “The Treasury market as a safe haven — that bid is certainly back and then some as we begin 2014. There's a place for the most liquid asset class in the world.”

(Bloomberg News)


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