The financial markets’ current $3,500bn question can be stated as a thought experiment: what happens
to US Treasury yields when the biggest buyer, the Federal Reserve, bows out? Star bond fund manager Bill Gross reduces the analysis to three pie charts: “Who Bought?”, Who’s Buying Now?” and, critically, “Who Will Buy?”. The Fed, 70 per cent of “Who’s Buying Now?” will be replaced by a question mark in June. Mr Gross’s simple and plausible conclusion is that yields must rise to attract alternative purchasers.
But things may not be so straightforward. Interest rate strategists at Credit Suisse see stable or falling yields through year-end because traditional investors, now underexposed to Treasuries fearing the end of QE, will respond to a weakening economy (signs of which they say are already evident). A similar counter-intuitive logic led them to correctly predict that the big rally in bonds in anticipation of QE2 between August and November would reverse just as the Fed began buying. The market had quite simply bought the rumour and, up to its eyeballs in fixed income exposure, sold the fact.