Closer Fed gets to rate boost, less bearish bond economists get

[NEW YORK] The bond market's best and brightest keep walking back their bets on how fast Treasury yields will rise.

Even with the Federal Reserve poised to begin raising interest rates for the first time in almost a decade, economists at the world's biggest bond shops now say they don't see benchmark yields reaching 3 per cent until the fourth quarter of next year, according to a Bloomberg News survey. As recently as December they were calling for Treasury 10-year yields to top 3 per cent by year-end.

Bond gurus continue to cut their expectations for how high yields will go amid signs of global economic malaise and persistently weak inflation. China's devaluation of the yuanthis week is the latest development to boost the allure of US government bonds and drag Treasury yields lower, complicating Fed chair Janet Yellen's efforts to boost rates.

"This is the new normal we have to get used to," said Stanley Sun, a New York-based strategist at Nomura Holdings, one of 22 primary dealers that trade with the Fed. "Long- term rates are behaving in their own world, reacting to global factors, while the Fed raises short-term rates." Nomura forecasts the 10-year Treasury yield will end this year at 2.4 per cent and next year at 2.9 per cent.

Ten-year yields dropped 0.04 percentage point in the week through Thursday to 2.19 per cent, in part as China's new currency strategy raised red flags about the strength of the global economy. The last time they hit 3 per cent was in January 2014.

"The weak Chinese economy seems to require a competitive devaluation against other Asian producers which points to weak global growth, lower commodity prices and again, lower inflation worldwide," Bill Gross, a money manager with Denver-based Janus Capital Group Inc. who formerly ran the world's biggest bond fund at Pacific Investment Management, said by e-mail on Tuesday. "The disinflationary-deflationary effect will keep 10- and 30-year Treasuries well-bid." Traders are pricing in a 50 per cent chance that the Fed raises rates at its September meeting, based on the assumption that the effective fed funds rate will average 0.375 per cent after liftoff. The probability of an increase by December is 74 per cent.

BLOOMBERG