The bond bear market, touted by billionaire fund managers Bill Gross and Ray Dalio, is about to run into a multibillion-dollar roadblock.
Strategists across Wall Street, from Credit Suisse Group to J.P. Morgan Chase, predict that the runup in stocks will spur portfolio rebalancing by U.S. pension funds, driving pent-up demand into bonds as managers shift their more than $7 trillion in assets. While the S&P 500 index has returned about 6.2% since the beginning of the year, 10-year Treasury futures have slumped 1.5%, pushing yields to near the highest since 2014. The bond benchmark was little changed in trading Thursday.
With those profits and losses in mind heading into month-end, pension funds will purchase about $24 billion in fixed-income securities, while selling an unusually high $12 billion of U.S. equities, according to a Credit Suisse model. And they don't have many more chances to make the shift: funds have less than five trading sessions to complete their month-end allocation requirements. On top of that, the Federal Reserve's policy meeting falls on Jan. 31, which may push some to get their trades done early.
All told: don't be surprised if the Treasuries sell-off pauses for a deep breath.
"One of the biggest forces supporting fixed income are the rebalancing flows emanating from multiasset investors who are trying to prevent the equity weightings of their portfolios from rising too much," J.P. Morgan strategists led by Nikolaos Panigirtzoglou wrote in a report. There's "more significant rebalancing required from this year's rapid gains in equity markets."
By J.P. Morgan's calculations, each 1% climb in stocks equates to $25 billion of bond buying by U.S. pension funds to keep their asset allocation balanced. State and local government defined benefit plans have about 60% in equities and 25% in fixed income, while for private plans, the split is closer to 50-40. In total, that's $125 billion of rebalancing in the wings.
The vast majority of pension fund purchases will probably be longer-dated Treasuries, supporting the trend of yield-curve flattening. The spread between five- and 30-year securities remains close to the narrowest since 2007. The Fed's three interest-rate hikes last year boosted yields in the short end, but have done little to rattle the longest maturities.
That's in no small part because of the demand from pension funds. Yields of 2.92% on 30-year Treasury bonds are enough for the average European pension fund to start derisking, and building up its stake in bonds. Many U.S. state and local pensions have loftier return requirements.
Despite the prognostications for higher yields, Treasuries aren't about to lose their appeal for captive buyers. On top of pension fund demand, funds tracking the Bloomberg Barclays US Treasury index need to buy more too, with the benchmark's Treasury duration increasing at month-end by 0.08 years, compared with the average 0.06 years over the past decade.
Even with anxiety about rising debt supply in 2018, as long as the stock market keeps up its bull run, there should be increased pension fund demand to match it.