Analysis: U.S. Treasuries seen weakening in 2014 but rout unlikely

Fri Jan 3, 2014 4:44pm EST
 
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By Richard Leong

NEW YORK (Reuters) - Investors who bet heavily on Treasuries took a beating in 2013, and as the Fed winds down its bond buying, they face the risk of a second straight losing year, something that has not happened in four decades.

Portfolio managers at large U.S. bond funds are, however, a bit optimistic. They say the most violent adjustment in the bond market has already happened, even though bond yields should rise a little more in 2014 as the Federal Reserve reduces its massive stimulus program.

Some analysts have long foreseen a protracted rise in yields after nearly 30 years of steadily falling rates. But the consensus among managers is that benchmark 10-year Treasury yields should peak around 3.5 percent this year, up from 3 percent now and remain otherwise in a tight range. A 50-basis point rise would pale against the 125 basis-point rise in yields in 2013.

"We don't expect another aggressive bond sell-off. I think even with the Fed tapering, policy accommodation will remain pretty high in 2014," said Jennifer Vail, head of fixed-income research at U.S. Bank Wealth Management in Portland, Oregon.

Another surge in yields would mean more misery for bond investors, including Bill Gross, who runs the world's biggest bond fund, the Pimco Total Return Fund PTTRX.O. That fund suffered its first annual loss since 1999, a negative return of nearly 2 percent.

But if the rise in yields is moderate and orderly, Gross and other investors who are bullish on Treasuries would have plenty of time to adjust their portfolios to reduce losses and take on bets in other bond sectors.

Fund flows into Treasuries in 2013 were slower than any other year since 2000. Pension funds, insurance companies, college endowments and foreign investors could find greater appeal in Treasuries as yields edge higher in coming months, but retail investors might still shy away from bond funds, particularly given the buoyant outlook for equities.

"Any zig-zag in rates will have retail investors very nervous," said Quincy Krosby, market strategist at Prudential Financial in Newark, New Jersey, which oversees $1 trillion in assets.   Continued...

 
U.S. Federal Reserve Chairman Ben Bernanke responds to reporters during his final planned news conference before his retirement, at the Federal Reserve Bank headquarters in Washington, December 18, 2013. REUTERS/Jonathan Ernst