August 7, 2019 / 4:06 PM / 14 days ago

UPDATE 2-Negative U.S. bond yields may become reality - PIMCO

(Adds Pimco group CIO Dan Ivascyn)

By Richard Leong and Jennifer Ablan

Aug 7 (Reuters) - Investors may have to grapple with the possibility of the once-unthinkable becoming reality - negative U.S. Treasury bond yields, according to money manager Pacific Investment Management Co (PIMCO).

Despite their dramatic drop since last week, U.S. Treasury yields remain among the highest for developed economies as the United States continues to enjoy its longest-ever expansion.

But a deteriorating global outlook exacerbated by an escalating trade war between China and the United States, the world's largest economies, has stoked a torrent of demand for low-risk government debt.

Most German and Japanese bond yields are currently in negative territory.

"It is no longer absurd to think that the nominal yield on U.S. Treasury securities could go negative," Joachim Fels, PIMCO’s global economic adviser, wrote on Wednesday in a blog post.

The negative rate policy and massive bond purchases by the European Central Bank and the Bank of Japan have resulted in about $14 trillion, or 25%, of the total amount of bonds around the world posting negative yields, Fels noted.

"However, we believe central banks are not the villains but rather the victims of deeper fundamental drivers behind low and negative interest rates. The two most important secular drivers are demographics and technology," Fels wrote.

In the United States, if the Federal Reserve reduces domestic borrowing costs to near zero and restarts quantitative easing to avert a recession, negative yields on U.S. Treasuries "could swiftly change from theory to reality," according to Fels.

In an interview with Reuters, Dan Ivascyn, group chief investment officer at PIMCO, which oversaw $1.84 trillion in assets under management as of June 30, said the company prefers U.S. Treasuries to other high-quality bond markets such as Germany, Japan and even Australia.

U.S. Treasuries are "one of the last high-quality bond markets to have room to rally significantly from here."

On Wednesday, U.S. 30-year bond yields fell to 2.123%, not far from their all-time low of 2.089% set in July 2016, according to Refinitiv data.

Interest rates futures implied traders have positioned for the possibility that the Fed would lower interest rates at every policy meeting the rest of this year, according to CME Group's FedWatch program.

Last week, Fed policymakers cut interest rates for the first time since 2008. They lowered the target range on domestic borrowing costs by a quarter point to 2.00%-2.25%.

The Fed also decided to end the shrinkage of its massive bond holdings, currently at about $3.6 trillion, earlier than planned.

Reporting by Richard Leong; editing by Bernadette Baum, Dan Grebler and Jonathan Oatis

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