Bond investors that drove two-year Treasuries down on Aug. 21 by the most since early June after Federal Reserve Chairman Ben S. Bernanke said the economy is “beginning to emerge” from recession may find themselves wishing they had held onto the securities.

While the comments sparked speculation that the central bank may soon raise borrowing costs as growth resumes, history shows the Fed is likely to keep its benchmark interest rate at a record low for a year or more. Policy makers didn’t boost rates after the 2001 recession until 12 months into the recovery, while it was 17 months following the 1991 economic contraction.
“It’s going to be very difficult for the Federal Reserve to raise rates simply because there’s no inflation,” said Michael Cheah, who manages $2 billion in bonds at SunAmerica Asset Management in Jersey City, New Jersey. “The two-year at a yield of 1 percent is an excellent yield,” said Cheah, who has been buying the securities.
The yield on the benchmark two-year note rose almost 11 basis points at the end of last week, or 0.11 percentage point, to 1.1 percent, according to BGCantor Market Data. That was the most since it surged by the same amount on June 8.
The slump came after the National Association of Realtors said sales of existing U.S. homes jumped 7.2 percent to a 5.24 million annual rate, the most since August 2007, and Bernanke said at a Fed-hosted central bankers’ symposium in Jackson Hole, Wyoming, that “prospects for a return to growth in the near term appear good.”
Trading positions show that the sell-off may be short-lived, even as the government prepares to sell $109 billion of Treasury notes this week, including $42 billion of two-year securities.
Speculative long positions on two-year notes, or bets prices will rise, outnumbered short positions by 158,041 contracts on the Chicago Board of Trade last week, the most since Dec. 7, 2007. That was just before the securities, which are more sensitive to changes in Fed policy than longer-term debt, posted their biggest quarterly gain since 2001, returning 3.26 percent, Merrill Lynch & Co. indexes show.
Zurich-based Credit Suisse Group AG, whose February recommendation to buy Treasuries due in two years earned about 0.85 percent versus the overall Treasury market’s 0.7 percent loss, predicts yields will fall to 0.7 percent by the end of the year, according to data compiled by Bloomberg. If accurate that scenario would produce about a $1,000 return on a $10,000 investment.
Strategists at New York-based JPMorgan Chase & Co., the second-largest U.S. bank, said in an Aug. 21 report that they “recommend maintaining longs” on shorter-maturity U.S. debt. The firms are two of the 18 primary dealers of government securities that trade with the Fed.
“Macroeconomic fundamentals continue to point to a Fed that is likely to maintain a low-for-long stance,” the JPMorgan strategists, led by Srini Ramaswamy, wrote in the report.
The inflation rate was unchanged in July after rising 0.7 percent in June, the Labor Department in Washington said on Aug. 14. Investors are betting consumer prices will fall 0.26 percent over the next 12 months and rise 0.28 percent over the next two years, compared with an average increase of 2.7 percent the past five years, prices of inflation-protected Treasuries, or TIPS, show.
Fed Vice Chairman Donald Kohn said the central bank’s current policy to keep rates low for a long time is aimed at promoting price stability and not at spurring inflation.
“The commitment to low rates is designed to keep inflation from falling and falling persistently below what we might want it to be for a long time,” Kohn said on Aug. 22 during an audience-debate period at a the Jackson Hole symposium. “It’s not designed to raise inflation expectations. There’s no inconsistency there.”
(Source: Bloomberg)