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US yield at 2% makes traders query 'animal spirits'

Singapore - Treasury benchmark yields that fell to 2% this month are raising concern that the US economy is losing momentum.

Yields tumbled as a 8% decline in the Standard & Poor’s 500 Index this month, crude oil at a 12-year low and falling inflation expectations sent money managers to the haven of government securities. While the US is adding jobs, manufacturing is contracting at the fastest pace in six years. Investors are trimming forecasts for how much the Federal Reserve can raise interest rates.

“The American economy has lost its animal spirits,” said Hideaki Kuriki, a bond investor in Tokyo at Sumitomo Mitsui Trust Asset Management, which oversees $55bn. “The potential growth rate of the American economy is going down. Longer term, yields may go down.”

Treasuries fell for the first time in five days on Tuesday with the benchmark 10-year note yield climbing two basis points to 2.05% as of 10:56 a.m. in Tokyo, according to Bloomberg Bond Trader data. The price of the 2.25% security due in November 2025 dropped 5/32 $1.56 per $1 000 face amount to 101 3/4.

The yield dropped to 1.98% last week, reaching a three-month low and thwarting analysts who projected the benchmark would rise after the Fed increased rates in December. Treasuries resumed trading in Asia Tuesday after being closed worldwide Monday for a US holiday.

‘Animal spirits’

Economist John Maynard Keynes used the term “animal spirits" in the 1930s to describe the importance of consumer confidence in driving business activity. The Japanese experience shows it’s not easy to evoke them, as economic growth and bond yields both hover near zero. Sumitomo Mitsui Trust’s Kuriki said Treasury yields may be less than 2% for the next three- to-five years.

The difference between yields on 10-year notes and similar-maturity Treasury Inflation Protected Securities, a gauge of expectations for consumer prices over the life of the debt, was 1.38 percentage points. The spread shrank to 1.379 on September 29, the narrowest since May 2009.

The odds that the Fed will raise its benchmark at least once in 2016 have fallen to 69% from 93% at the start of the year, according to data compiled by Bloomberg based on futures contracts.

Expecting pickup

January’s flight to quality and tumble in yields won’t automatically translate into an economic slowdown, said Tomohisa Fujiki, head of interest-rate strategy for Japan for BNP Paribas SA in Tokyo. The company’s US unit is one of the 22 primary dealers that trade directly with the Fed.

“This 2% itself does not instantly mean recession,” Fujiki said. “We are expecting a pickup in activity in the first quarter of 2016,” The yield will rise to 2.75% by December 31, BNP predicts.

Mizuho Asset Management has the opposite view.

“Recession is too strong” a word to describe the economy, said Yusuke Ito, a senior investor in Tokyo at the company, which oversees about $42.5bn. “Stagnant is a better word. Growth is going to be sluggish for a long time.” He’s betting on long-term Treasuries, he said.

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