Bond investors are planning to hedge against a sudden rise in interest rates that would trigger a selloff parallel to 1994, said a New York-based credit strategist at Morgan Stanley. (MS)
Treasuries returned 9.8 percent in 2011, and 10-year debt gained 17 percent, Bank of America Merrill Lynch data show, as the Federal Reserve held its benchmark rate near zero since December 2008. Government debt dropped 3.3 percent in 1994 after the Fed almost doubled the target for the federal funds rate to 5.5 percent in response to inflation threats, the data show. Treasuries have slid 0.26 percent this year.
“The fear is that you have a dovish Fed for a long time, and then all of a sudden they start raising rates,” which “led to the bloodbath in bonds in 1994,” he said. Bond investors “are trying to avoid a similar outcome, and hence the move higher in yields we’ve seen at least on a micro level here recently.”
The central bank pledged to keep rates at a record low zero to 0.25 percent through 2014 and it also bought $2.3 trillion of bonds in two rounds of so-called quantitative easing. An increase in rates may lead to a selloff in debt markets, Hussain said.
Treasury 10-year notes fell for a ninth consecutive trading day today, the longest stretch since June 2006, as investors bet a strengthening economy will diminish the refuge appeal of U.S. government debt. Yields on the benchmark security reached the highest since October last week after the Fed raised its assessment of the economy, driving investors to riskier assets. Today it rose to 2.39 percent at 3:09 p.m. in New York, according to Bloomberg Bond Trader prices.
Clients are asking how to protect against a spike in rates, he said. Volatility, as well as the absolute level of rates, matters when it comes to protecting credit, so “kill off the volatility” and it will provide a much better investing environment, he said.
Bonds were hurt in the the 1994 selloff, he said. The spread widening was mostly manageable, he said, pointing out that yield margins were starting from a much tighter level than where they are now.