The US bond market could enjoy a solid 2015, but don't expect a repeat of the spectacular run that some fixed-income sectors enjoyed this year, investors said on Wednesday. US government debt that matures in 20 years and beyond is on track for a 27 percent return for 2014, according to Barclays, in a year when the S&P 500 index has gained nearly 15 percent. Investors bought long-dated debt in a bet that a very steep yield curve - the difference between short- and long-dated yields - would narrow. It did, sharply.
Barclays' widely followed US Aggregate bond index, which tracks Treasuries and other US investment-grade bonds, earned a 5.88 percent return through Tuesday. It rebounded from a 2.02 percent loss last year, its second-worst performance since 1976. The major bond indexes rarely end in negative territory because coupon payments buoy returns even if prices don't appreciate. "Treat next year as being more defensive in your approach," said Brian Brennan, a portfolio manager at T. Rowe Price in Baltimore. "Obviously, valuation is stretched."
Initially forecast for an increase in 2014, benchmark 10-year Treasuries yields instead declined more than 80 basis points this year, to hit 2.18 percent on Wednesday. Few analysts forecast yields to fall next year, barring a rapid economic deterioration.
Whether the Federal Reserve raises interest rates next year is arguably the No 1 factor that will determine the fortune of Treasuries, corporate bonds and other US debt.
Many of Wall Street's top banks expect the Fed will end its near-zero interest rate policy in mid-2015 on evidence of better jobs conditions and business activity. "There is no purpose for the Fed to continue with near-zero rates," said Roger Aliaga-Diaz, senior economist at Vanguard, in Malvern, Pennsylvania. Expectations of a rate hike will likely cause short-dated debt to continue to sell off and raise those yields, as occurred in 2014. The question is whether long-dated yields will follow suit. Weak inflation figures, concern about global growth, and the demand for US assets could restrain any rise in long-dated yields. In that case, if the 10-year note falls to 2 percent, that would boost returns for long-dated yields again. Such a move, along with estimated gains from interest payments, would put 10-year securities in line for returns of about 4 percent, way down from 11 percent in 2014.
Analysts said that what central bankers in Europe, Japan and China might to do help their economies would also play a critical role. European and Japanese policymakers are expected to act to stimulate their economies, which would bring their record low yields even lower. That could push overseas investors to pour more money into the US bond market for its relatively higher yields. "The supply and demand technicals in the fixed-income market remains healthy," T. Rowe's Brennan said. Not all US bonds fared as well as long-dated Treasuries. Junk bonds and Treasury inflation-protected securities (TIPS) were torched in the second half of the year, partly on the steep drop in oil prices.
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