US Treasury bonds strengthened further this month, with the yield on the benchmark 10-year bond reac...
US Treasury bonds strengthened further this month, with the yield on the benchmark 10-year bond reaching 3.08% in mid-June, the lowest for a Treasury with 10 years left to maturity since 1958.
This was prompted in part by anticipation of a further interest-rate cut from the Federal Reserve when it meets next week. Since the Iraqi war was concluded, US policy has been 'pedal to the metal'. Monetary policy is very stimulative, a massive fiscal boost through tax cuts is passing through Congress, oil prices are off their highs, and the dollar has weakened sharply, most notably against the euro.
In its most recent announcement, the Fed announced that it had separated the outlook for growth, where the forces seem evenly balanced, from pricing, where there is now a clear asymmetry in favour of downward pressures. The implications of this statement are profound, namely that even with slightly higher levels of growth, US interest rates will stay low, perhaps even lower than they are today, for a considerable period into the future. At the same time, in the absence of stronger demand from abroad, the administration will tolerate a considerable weakening in the external value of the dollar.
In part also, this strengthening in US Treasuries has been prompted by a flight to quality in the face of scandal at mortgage lender Freddie Mac, which announced the dismissal of its president and resignations of the chief executive and chief financial officer last week.
The company, which was privatised in 1989, stated in a press release that the president had failed to co-operate with an audit investigation into the way Freddie Mac compiles its accounts, and indeed had tampered with evidence.
Five months ago the company, the second biggest in this market with mortgages on one in six American homes, reported a change in accounting for derivatives suggested by its new auditors.
It also said that it would be restating earnings for the last three years as a consequence. This latest announcement prompted a full regulatory investigation into the way the company operates.
The immediate consequence of the announcement was a 16% drop in shares in Freddie Mac, and a widening of the difference between yields on US Treasuries and Freddie Mac bonds as investors perceived additional risk in holding the mortgage agency bonds.
We still believe that US Treasuries are on the expensive side of fair value. There might still be a little further to go, particularly if the Fed lowers interest rates again, but ultimately we don't think these levels are sustainable in the long term.
We also remain cautious on the prospects for agency debt given the increased uncertainty in the market in the wake of the news at Freddie Mac. Instead, our preference in the US is for a mix of cash and longer dated government bonds; or to reach quite far down the credit spectrum to high yield bonds, where we believe there is still some upside.
US Treasuries have strengthened.
Treasuries may strengthen further.
High yielding bonds still offering some upside.
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