Trouble lies ahead for US Treasury bonds

Matt Clinch
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U.S.Treasury To Insure Money Market Mutual Funds
The relative attraction of bonds over equities changes at four per cent (Source: Getty)

Global equities pulled back Monday, as the US benchmark yield closely hovered around the psychologically significant three per cent level.

Traders and analysts were busy trying to explain its importance, with all of them noting that 2014 was the last time that the 10-year government bond was at such a handle.

Reuters says that this level had previously triggered “market spasms”, “rocked risk appetite”, and also came shortly before oil’s 75 per cent price tumble.

However, some cooler heads in the investment community were quick to point out that it is just a number.

Ben Rogoff, a fund manager at Polar Capital Partners, told CNBC that the real concern would be when the interest rate on that bond neared 3.5 per cent, and even higher.

“There’s trouble ahead and I think that really does explain the change in volatility that we are seeing in markets,” he says.

Rogoff believes that at four per cent for the US 10-year bond, pension funds around the world start to immunise their portfolios.

The fund manager says the relative attraction of bonds over equities changes at four per cent.

He adds that at 3.5 per cent, equity markets struggle to expand their price-to-earnings (PE) ratios – which is an important metric used by traders to gauge the value of a company’s stock.

Traditionally, higher rates make equities less attractive, but it can also signal that an economy could be at risk.

As the 10-year is such a benchmark for global debt, it means that the debt repayments for a whole range of companies also rise. These companies therefore have to spend more to finance their debts.

The worry is that companies get squeezed, and are forced to pull back on investment.

“I think what we’ve probably seen earlier in the year – in January when yields were lower and volatility was still looking very much like 2017 – we may have seen peak PE on equity markets, which again is a very big statement to make,” Rogoff adds.

Over the weekend, research from Morgan Stanley analysts said that a break above three per cent suggested that 3.25 per cent wouldn’t be far behind. The investment bank also turned “tactically neutral” on the US Treasury market as “risk-reward looks poor”.

It could be an interesting few months for markets.

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