Unstoppable $100 trillion bond market renders models useless

If the insatiable demand for bonds has upended the models you use to value them, you’re not alone. More

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Unstoppable $100 trillion bond market renders models useless

Posted 6/2/14

NEW YORK - If the insatiable demand for bonds has upended the models you use to value them, you’re not alone.

Just last month, researchers at the Federal Reserve Bank of New York retooled a gauge of relative yields on Treasuries, casting aside three decades of data that incorporated estimates for market rates from professional forecasters. Priya Misra, the head of U.S. rates strategy at Bank of America Corp., says a risk metric she’s relied on hasn’t worked since March.

After unprecedented stimulus by the Fed and other central banks made many traditional models useless, investors and analysts alike are having to reshape their understanding of cheap and expensive as the global market for bonds balloons to $100 trillion. With the world’s biggest economies struggling to grow and inflation nowhere in sight, catchphrases such as “new neutral” and “no normal” are gaining currency to describe a reality where bonds are rallying the most in a decade.

“The world’s gotten more complicated and it’s a little different,” James Evans, a New York-based money manager at Brown Brothers Harriman & Co., which oversees $30 billion, said in a telephone interview on May 30. “As far as predicting direction up and down, I don’t think they have much value,” referring to bond-market models used by forecasters.

Flawed consensus

With the Fed paring its $85 billion-a-month bond buying program this year and economists calling for the five-year-long U.S. expansion to finally take off, Wall Street prognosticators said at the start of the year that yields were bound to rise as central banks began employing tighter monetary policies.

Instead, investors poured into bonds of all types as global growth weakened, disinflation emerged in Europe and tensions between Ukraine and Russia intensified.

Globally, bonds have returned an average 3.89 percent this year for the biggest year-to-date gain since 2003, index data compiled by Bank of America Merrill Lynch show. The advance decreased yields on 10-year Treasuries by more than a half percentage point to 2.48 percent, the fastest pace over the same span since 1995, while borrowing costs for the riskiest U.S. companies tumbled to a record 5.94 percent last week.

Benchmark Treasury 10-year note yields rose one basis point, or 0.01 percentage point, to 2.49 percent as of 8:02 a.m. New York time.

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