Global investors poised to buy US Treasuries if 10-year gets into 1.25-1.3% range

New York

THE US Treasury market's bears had better take notice: There is a wall of global cash poised to swoop in and buy, likely limiting the upside in yields.

The prospect of a unified Democratic government has jump-started inflation expectations, catapulting long-term Treasury yields back to heights last seen in March 2020 - and approaching levels where many international investors say they would look to buy.

For money managers in Asia and Europe monitoring the world's biggest economy, there is a sense that the peak in yields may not be far off, amid concern over the fallout from soaring virus cases and the slow roll-out of vaccines. There is also the likelihood that US President-elect Joe Biden's US$1.9-trillion stimulus proposal is going to face hurdles in a closely divided Congress that is also about to take up impeachment proceedings.

The upshot is that investors in Europe, and particularly in Japan - the biggest overseas holder of American government debt - have their sights set on buying more if the 10-year gets into the 1.25 per cent to 1.3 per cent range, and the 30-year to around the 1.92 to 2 per cent zone. In both cases, that is a mere 10 basis points - even a bit less - above the latest peaks seen before the surging reflation trade appeared to lose momentum.

"The trajectory on the virus is creating downside risks for economic data," said Mark Dowding, chief investment officer in London at BlueBay Asset Management, which oversees about US$67 billion. "Over the next few months, the 10-year yield should range between about 1 per cent and 1.25 per cent", and the firm would look to buy if yields breached the top end, he said, with 2 per cent serving as the key point for 30-year bonds.

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Foreign demand has always been a key component of prognosticating in the Treasuries market, and there are far-reaching implications from this looming appetite. For one thing, it stands to limit the cost to US taxpayers of financing the nation's swelling debt load, at roughly US$21 trillion and counting. But it also means investors in other asset classes may have less to fear from climbing Treasury yields.

The biggest bond dealers have a mixed take on what is next for yields. HSBC last week recommended buying Treasuries on what it called an "overdone" sell-off. Meanwhile, Goldman Sachs raised its year-end target for 10-year yields to 1.5 per cent from 1.3 per cent, given the "greater fiscal impulse" likely under unified Democratic control of government.

But overseas buyers may not wait for rates to get that high, with cracks in the growth-rebound story emerging. The past week saw the biggest jump in filings for jobless claims since March, and an unexpected decline in retail sales.

"The risks around the economic outlook are huge," said James Athey, a London-based money manager at Aberdeen Standard Investments, which oversees over US$560 billion. "There are risks in both directions, but I'd argue the preponderance are to the downside - towards less positive growth outcomes, less positive virus outcomes, less positive vaccine outcomes. If 10-year yields get to 1.25 to 1.30 per cent, I'd be comfortable adding to my long-duration positions."

Wall Street chart-watchers are looking at that area too as the next big obstacle for yields, given the level of roughly 1.27 per cent represents the peak seen in the market pandemonium of March.

There are already signs that the bond market sell-off is luring buyers. Last week, investors lapped up the Treasury's sales of 10-year notes and 30-year bonds. The coming week brings a US$24 billion auction of 20-year debt.

For the global bond market, much rides on the preferences of Asia-based investors. Japan owned about US$1.3 trillion of Treasuries as at October, the biggest foreign pile. China is next with about US$1.1 trillion, the least since 2017. On Tuesday, the government releases data for November. Markets are closed on Monday for Martin Luther King Jr Day.

So far, Japan's buyers are biding their time. For this key investor segment, yields are not quite high enough to give them confidence as they have limited potential capital losses. That comes even as the yen has reached the stronger end of its recent ranges, and as the cost of currency hedging has dropped.

"There won't be much of an outflow from Japan until Treasury yields stop rising," said Takenobu Nakashima, chief rates strategist at Nomura Securities.

For Mr Nakashima, one strong signal will be if US 10-year rates, adjusted for hedging costs, consistently exceed 30-year Japanese government bond yields - which are around 0.65 per cent, up from around 0.25 per cent in March. That has been the case for roughly a week now.

"Japanese investors tend to buy big after confirming yields have peaked out - they aren't momentum riders," said Masahiko Loo, a fixed income portfolio manager at AllianceBernstein Japan. "There won't be a major outbound shift until 10-year yields rise to 1.3 per cent, as current levels would return just about 80 basis points after hedges, and buying at these levels likely is just confined to short-covering." BLOOMBERG