NEW YORK: It has already been a horrid year for investors in US Treasuries - and it could easily get much worse.
US government bonds ended August with their fourth straight monthly loss, down 3.43 percent on a total return basis in the four months, their worst such stretch since 1996, according to the Barclays Aggregate US Treasury Index .
Yields on benchmark 10-year Treasury notes have surged by 1.29 percentage points since their low-water mark around 1.6 percent in early May. But even at 2.89 percent on Wednesday, yields could move even higher, and prices lower, when the US Federal Reserve pulls back on its $85-billion-a-month buying of Treasuries and mortgage-backed securities, a process largely expected to begin with the Sept. 17-18 meeting of the Federal Open Market Committee.
"I don't know what the magic number is, but Treasury yields will be much higher than they are now by year-end," said Dan Fuss, vice chairman and portfolio manager at Loomis Sayles, which has $190 billion in assets.
Altogether, there is plenty of scope for 10-year yields not just to breach the psychologically key 3 percent barrier - a level unseen since July 2011 - but to overshoot and notch further multi-year highs in coming months.
This matters because US government debt is used as a benchmark for pricing a huge range of other interest rates, from home mortgages to complex derivatives around the world.
The Fed's purchases have swollen its balance sheet to a record $3.6 trillion, but the Fed isn't looking to stop its buying just because it owns so much of the market.
By several measures, the US economy is picking up steam, meaning the Fed doesn't need to prop up the economy as much. Growth in US home prices and manufacturing orders, including robust auto sales, have been among the positive economic signs. Jobs growth has been solid, though unspectacular.
Price pressures could also speed up, potentially prompting the Fed down the road to pay more heed to the inflation half of its dual mandate of promoting maximum employment and stable prices.
Historically speaking, yields continue to be quite low. As recently as 2007, benchmark yields rose above 5 percent.
"The market has underestimated the risk that inflation pressure actually may not continue subsiding and may even turn around," said Pippa Malmgren, president of Principalis Asset Management, who advises investors on policy and political risk. She pointed to price pressures in emerging markets that could bleed into industrialized countries.
Recent inflation data was strong enough to prompt even some longtime inflation bears to throw in the towel.
"I've been in the deflation camp for two decades ... but strongly feel it is time to move on," said David Rosenberg, chief economist and strategist of Gluskin Sheff and Associates, to clients last month.
While worries about a potential US military strike against Syria took yields off their two-year highs recently, Treasuries are selling off again now that such action has been delayed.
An unexpectedly long engagement in Syria could rekindle a bid for Treasuries. And should another standoff between the White House and Congress over raising the debt limit roil other markets, Treasuries could benefit from a flight to safety even against the risk of a technical default, as happened in 2011.
Still, it largely comes down to the Fed. With data pointing to an improving jobs market and faster second-quarter growth, some Fed speakers say it is time to wean the economy off the bank's substantial help.
Most economists in a Reuters poll see tapering of the bond buying program starting at the bank's meeting later this month.
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