Credit Markets

U.S. Government Bonds Strengthen to Close Out a Big Year

Investors Have Gained Largest Total Calendar-Year Return Since 2011

By Min Zeng

Updated Dec. 31, 2014 2:47 p.m. ET

U.S. government bonds strengthened Wednesday on the last trading session of 2014, capping the biggest annual rally in three years.
A number of global economic, geopolitical and market scares throughout the year have boosted investors’ demand globally for ultrasafe Treasury bonds.
The yearlong price strength in ultrasafe U.S. government debt has stunned many investors, traders and analysts because the safe-haven bond market rallied along with record-high stock prices. At the start of last January, the consensus was for bond prices to extend their losses of the year before, driven by a U.S. economy gaining steam and the gradual winding down of the Federal Reserve’s monthly bond purchases.
On Wednesday, the yield on the benchmark 10-year Treasury note fell to 2.173% as of 2 p.m., when the bond market was shut ahead of the New Year’s Day holiday. That’s a big tumble from the 3.03% yield at the end of 2013, marking the biggest calendar-year decline since 2011.

Bond prices rise as yields fall.
Treasury bonds overall have handed investors a total return, including price changes and interest payments, of 4.95% this year through Tuesday. That is the biggest calendar-year return since 2011, according to data from Barclays PLC.
“Global investors see Treasury bonds as one of the best liquid and relatively attractive hedges against a plethora of global risks,” said Tony Crescenzi, senior market strategist at Pacific Investment Management Co. in Newport Beach, Calif., which had $1.87 trillion in assets under management as of Sept. 30.
Growth has been stagnant in the eurozone, Japan is in recession and China’s economy has slowed from the torrid pace a decade ago. Falling oil prices since the summer have hurt growth prospects in countries relying heavily on energy exports, generating a currency crisis in Russia this month.
Adding to the list has been this week’s political turmoil in Greece after the nation’s parliament failed to elect a president.
“With uncertainty around the impact of a swift drop in oil and slower global growth, you have an environment where exposure to risk assets may be questioned, therefore Treasury yields and overall interest rates are capped,” said Sean Simko, head of fixed-income management at SEI Investments in Oaks, Pa., which has $146 billion in assets under management.
Another boost for Treasury bonds has been fresh monetary stimulus from the European Central Bank and the Bank of Japan .
Both have stepped up, printing money in recent months to support their flagging economies even as the Fed is prepared to start raising interest rates next year thanks to a stronger U.S. economy.
The liquidity from the ECB and BOJ has encouraged investors to buy national governments’ bonds, sending yields in Japan and many eurozone countries to record lows earlier this month.
The yield on the 10-year government bond in Germany settled at 0.542% Wednesday, down from 1.927% at the end of 2013, according to Tradeweb.
The yield on the 10-year U.K. government bond closed at 1.759% Wednesday, down from 3.039% at the end of 2013.
The sharper decline in yields in Europe has turned U.S. Treasury bonds into an attractive bargain. A rallying dollar this year, driven by the prospect of higher interest rates from the Fed in 2015, has allowed foreign investors to pick up extra gains.

“The U.S. decoupled from the rest of the world when it comes to growth but not when it came to U.S. rates,” said Priya Misra, head of U.S. rates strategy research at Bank of America Merrill Lynch in New York. U.S. yields won’t rise sharply in 2015 “given weak global growth and inflation and easing by other central banks.”

Many big banks have been forced to lower their yield forecasts in 2014 and now they are more modest in their yield predictions for next year. J.P. Morgan Chase & Co. expects the yield on the 10-year Treasury note to rise to 2.7% at the end of 2015. Bank of America expects 2.75%, and Goldman Sachs Group Inc. expects 3%.

Lower Treasury bond yields have sent ripples through other markets, pushing up the value of riskier bonds and stocks. Many U.S. portfolio managers have dabbled into riskier bonds that offer higher yields than Treasury debt to juice returns.

U.S. municipal bonds have been the best-performing U.S. asset class this year, posting a total return of 8.97% as of Tuesday, according to Barclays. U.S. investment-grade corporate bonds also beat Treasurys, with a 7.39% return.

U.S. corporate bonds sold by lower-rated firms are laggards, with a return of 2.45%.

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