Bond traders' worst cocktail of 2017: long treasuries, dollar
Few bond traders around the world will raise a glass to toast US Treasuries and the dollar this New Year's Eve.
Among the countries represented in the Bloomberg Barclays global sovereign-debt index, US obligations had the worst 2017 total return on an unhedged basis – just 2.2% for dollar-based investors as of December 28. By contrast, bonds from Poland gained 25%, those from Thailand climbed 16% and securities from Italy and Spain earned more than 14%. Even in Japan, where yields are locked near zero, US investors squeezed out more than 3%.
At least it wasn't a loss, right? Think again. Unhedged Treasuries lost 1.1% in yen terms and tumbled 9.7% when measured in euros, based on the index.
When viewed that way, it's clear that the blame for paltry returns lies both with rising short- and intermediate-term Treasury yields and the greenback's worst year in more than a decade. Among major developed-market peers, the dollar weakened most against the euro, meaning that investors in Europe's shared currency zone received fixed payments worth less and less at home if they opted not to hedge.
"You end up with higher volatility because the currency effect tends to dominate the bond market effect," said Robert Sinche, global strategist at Amherst Pierpont Securities. "That has certainly been the case in the last four or five years, where bond markets have been relatively stable and currencies have been the things that move around."
It might not get any better in 2018. A majority of analysts surveyed by Bloomberg expect the pain will continue for the greenback, with the US Dollar Index forecast to slide 1.4% from its current level by the end of next year. And a poll of bond yield estimates reveals expectations for the 10-year Treasury yield to climb 51 basis points over the next 12 months, and the 30-year yield to jump 56 basis points.
Then again, strategists largely expected a stronger dollar in 2017. Sinche said he sees lots of reasons for the dollar to rebound in 2018, though 10-year Treasury yields could break out of their range and head upwards of 3% in 12 months' time.
Even the biggest bond fund managers can't seem to agree on a winning bet for 2018. Some say it's time to get defensive, while others are adding high-yield and emerging-market debt for larger returns.
It's shaping up to be an uncertain year. But after months of market volatility near record lows, that's something just about every trader can cheer.
What to watch in the coming week
- US bond and equity markets are closed January 1 for the New Year's Day holiday
- Among the week's main events, minutes of the Federal Open Market Committee's December meeting will be released at 2pm New York time on January 3
- The text may help traders assess how confident officials are about raising interest rates three times in 2018, the scenario indicated by their forward projections
- The St. Louis Fed's James Bullard speaks on January 4, while the Philadelphia Fed's Patrick Harker and Cleveland's Loretta Mester speak on January 5
Latest US jobs report is the highlight among economic indicators set for release:
- January 2: Markit U.S. manufacturing PMI
- January 3: MBA mortgage applications; construction spending; ISM manufacturing, prices paid, new orders and employment; Wards vehicle sales
- January 4: Challenger job cuts; ADP employment change; initial and continuing jobless claims; Markit U.S. services and composite PMIs; Bloomberg consumer comfort index
- January 5: Nonfarm payrolls, unemployment rate and average hourly earnings; trade balance; ISM non-manufacturing composite; factory orders; durable and capital goods orders
The Treasury won't auction any coupon debt, though it will issue an unprecedented $160 billion of bills on January 2 – the most ever on a single day.