Yields rise as US bond market changes direction

“US treasuries are looking very expensive at the moment,” comments Thursby. “The yield on 10-year treasuries is down to 4%, while 30-year treasuries are 4.9%. To become attractive, we would want 10-year treasuries yielding around 5.5% and 30-year treasuries on about 6%.”

As other fund managers, Thursby also says the price of US government bonds suggests the market thinks the economy is heading for a recession: “The economic statistics do not back up a view that a recession is coming. The economic and corporate news is very good at the moment. This is bad news for corporate bonds. There are three factors behind the rise in government bond prices; the least important is that hedge funds have gone long after being wrong for the past few months.

“Second, mortgage-backed investors have protected their positions by buying treasuries as the yield has fallen. Third, central banks in Asia have continued to buy treasuries. If bond prices fall and yields rise, then mortgage-backed investors will go the other way and start selling bonds.”

Thursby believes that the Federal Reserve will continue to raise interest rates until they reach around 3.5%, as economic growth is between 4% and 4.5% at the moment. If Thursby is right and the price of treasuries drops and the yield rises to 5.5%, this will give 10-year treasuries an attractive premium.

The risks to this attractive scenario, says Thursby, are the negative impact of rising US rates, the high price of oil and how much inflation comes through to the US economy, the presidential election, the cost of Iraq, low Chinese growth and whether Asian central banks continue to buy treasuries.