Analysis: U.S. Treasuries rout may be far from over

Thu Sep 5, 2013 1:20am EDT
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By Luciana Lopez and Jennifer Ablan

NEW YORK (Reuters) - It has already been a horrid year for investors in U.S. Treasuries - and it could easily get much worse.

U.S. 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 U.S. Treasury Index .BCUSATSY.

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 U.S. 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 September 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 U.S. 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 U.S. economy is picking up steam, meaning the Fed doesn't need to prop up the economy as much. Growth in U.S. home prices and manufacturing orders, including robust auto sales, have been among the positive economic signs. Jobs growth has been solid, though unspectacular.   Continued...

The sun rises to the east of the U.S. Federal Reserve building in Washington, July 31, 2013.REUTERS/Jonathan Ernst