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Bond traders can’t sleep as Fed policy becomes a foreign affair

Bond Traders

Bloomberg

Even in the mighty U.S. Treasury market, bond traders are taking their cues from central bankers in Europe and Japan.
With Mario Draghi and Haruhiko Kuroda pressing ahead with their grand monetary experiments, negative yields in Germany and Japan are exerting greater and greater influence over U.S. Treasuries. Overnight trading of Treasury futures has exploded, reaching levels not seen in years. Benchmark U.S. notes are also moving the most in tandem with German bunds since 2014.
The shift could have far-reaching consequences. As yields on trillions of dollars of euro-area and Japanese bonds sink further below zero, demand for Treasuries may mitigate any move by the Federal Reserve to push U.S. interest rates higher. What’s more, it may signal ultra-loose policies by the European Central Bank and Bank of Japan have the potential to undermine the Fed’s push to tighten, particularly if the dollar’s strength blunts inflation and growth.
“It used to be that everything was correlated to movements in U.S. Treasuries and now the U.S. seems to be following,” said Jim Caron, a money manager at Morgan Stanley Investment Management, which oversees $406 billion.
Treasuries are “being more dominated by global events.”
Despite the backup in Treasury yields this month, they’re still lower than they were in December, when the Fed ended its near-zero rate policy and boosted borrowing costs for the first time in a decade. Yields of the benchmark 10-year were at 1.99 percent as of 12:56 p.m. in Tokyo on Monday, versus 2.27 percent at the end of 2015.
Demand for government bonds has pushed borrowing costs in almost every industrialized nation down this year, with average yields on $23 trillion of bonds falling to a record 0.69 percent in February, according to data compiled by Bloomberg. More than a quarter of those securities yield less than zero.
A big part of it has to do with the unprecedented monetary easing that central bankers at the ECB and BOJ have undertaken to revive their moribund economies in the past year. In their latest announcements, the ECB surprised investors last week by cutting its deposit rate to minus 0.4 percent, increasing its bond buying and incorporating company bonds as part of its purchases. In February, the BOJ’s Kuroda added negative rates to its quantitative-easing program.
“Investors have to buy bonds,” said Hideaki Kuriki, a debt investor at Sumitomo Mitsui Trust Asset Management, which oversees $59 billion. “They can’t take risk.”
Those same forces are swaying the $13.3 trillion market for U.S. Treasuries.
The proportion of futures trading in Treasuries that happens during Tokyo hours has jumped to about 8 percent, from about 4 percent mid-2015, data compiled by JPMorgan Chase & Co. show.
A Goldman Sachs Group Inc. analysis of bond volatility showed that falling yields on Japanese government bonds have been defining the direction of the market.
Moves in Europe are also having a greater influence.
The BOJ and ECB, “what they do will have a reasonable impact on Treasuries,” says Krishna Memani, who oversees $204 billion as chief investment officer at Oppenheimer Funds Inc. in New York.

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