Treasury bull market shows few signs of ending

SERIOUS MONEY:The secular bull market in US treasury bonds that began way back in the autumn of 1981 has climbed a “wall of worry” for more than 30 years.

Myriad esteemed investment professionals have been embarrassed by their premature calls for an end to the seemingly relentless increase in prices that saw the yield on 10-year Treasuries drop from a peak of more than 15 per cent three decades ago, to below5 per cent by the turn of the new Millennium.

The extent of the downward move in yields appeared excessive to many but the collapse of the dot.comequity bubble allowed the bull market to continue. And the mercantilist policies pursued by much of the emerging world throughout the robust global economic expansion that followed ensured that long-term interest rates were sustained at historically low levels.

Treasury bonds continued to reward contrarians, who ignored consensus opinion, through the early years of the new Millennium. Conservative portfolios performed even better when the financial crisis struck in 2007, as the yield on 10-year Treasuries sank from over 5 per cent pre-crisis to just 3.5 per cent by the time the Great Recession came to an end during the summer of 2009.

More than three years into recovery, and the Treasury bull market has displayed few signs of ending. Yields on longer maturities have slid by a further 200 basis points (two percentage points) to all-time lows, as the economic expansion struggles to reach escape velocity.

The market’s continued resilience has sparked concerns, however, that yields are been kept artificially low not only by central bankers’ commitment to hold policy rates near-zero for an extended period, but also via aggressive quantitative easing programmes.

Several investment practitioners believe Treasury bond prices are in dangerous territory, and argue that investors in these supposedly risk-free assets could well end up shouldering uncomfortable losses in the not-too-distant future. But do the bearish concerns stand up under close scrutiny?

The Federal Reserve’s commitment to hold policy rates at close to zero through mid-2015 is likely to have had some effect on Treasury bond yields, since long rates reflect expectations of future short rates. However, the greater decline in the yields available on longer maturities vis-à-vis both short- and medium-term notes – ie the reduction in the term premium – suggests that policy commitments have played only a minor role.

Several analysts conclude that the drop in the term premium can be attributed to aggressive central bank bond buying via the much-publicised quantitative easing programmes. However, analysis of the Federal Reserves holdings of marketable Treasuries reveals that its share, at about 15 per cent, is roughly the same as it was pre-crisis. Though its relative holdings of longer maturities has increased, almost 70 per cent of the outstanding stock is held elsewhere.