Higgins says many see an end to the 10-year Treasuries rally as “inevitable” – a belief that has not been altered by the 10-year yield falling by 60bps since April – but says the forthcoming end of QE2 may in fact prove supportive to the Treasury market, noting that the withdrawal of stimulus measures will remove the incentive to seek out risk assets.
The yield on 10-year Treasuries has fallen below 3% for the first time this year; Higgins expects the trend to continue and believes the yield will hit 2.5% by the end of 2011.
The expected path of US short-term interest rates, a key determinant of long-term Treasury yields, is another supportive factor, according to Higgins. The senior markets economist at Capital Economics says that expectations of a rise in US rates “have already been scaled back significantly” but says his team expects the overnight rate to still be between 0% and 0.25% at the end of 2012, in part due to stuttering growth prospects in the US.
By contrast, in his latest investment outlook, Pimco’s Bill Gross says “there is not enough data to indicate whether the end of QE2 will lead to higher or even lower rates, although higher is our strong preference”.
He suggests, however, that there is “overwhelming evidence […] that existing Treasury yields fail to adequately compensate investors for the risk of holding them when measured on an historical basis”, pointing to a lack of value relative to inflation.
Pimco’s preference, says Gross, is “buying more floating and fewer fixed rate notes, adding an additional credit component – be it investment grade, high yield, non-agency mortgage or emerging market related – and shading your portfolio in the direction of non-dollar emerging market currencies.
