Deficits Don’t Matter as Geithner Gets Lowest Yield
U.S. treasury secretary Timothy F. Geithner. Photographer: Joshua Roberts/Bloomberg
For all the criticism of record budget deficits, President Barack Obama can take comfort knowing that for the first time in half a century, government bond yields are declining during an economic expansion and Treasury Secretary Timothy F. Geithner is selling two-year notes with the lowest interest rates ever.
The combination of record-low yields on two-year notes, 10- year rates below 3 percent and a deficit projected to surpass $1.4 trillion for a second consecutive year is a signal that the bond market is less concerned with government spending than with getting the economy back on track.
“The U.S. has been granted more time,” said Anthony Crescenzi, a portfolio manager and strategist in Newport Beach, California, at Pacific Investment Management Co., which oversees more than $1 trillion in assets. “Because of the concerns in Europe, money has flowed to the U.S., and so it does allow the U.S. to play the game for longer, and kick the can down the road on deficit reduction.”
Yields on two-year notes fell to 0.5516 percent on July 23, the lowest since regular sales of the securities began in 1975, on signs the expansion that began in the third quarter of 2009 is losing steam. Ten-year yields dropped to a 15-month low of 2.85 percent on July 21 as Federal Reserve Chairman Ben S. Bernanke said the economic outlook is “unusually uncertain” and the central bank is prepared to take more policy actions.
Highest on Record
While investors forced European governments to cut spending and grapple with their sovereign debt crisis and pushed yields on two-year Greek debt to 18 percent, demand at Treasury auctions is the highest on record. By keeping borrowing costs near record lows, investors are providing the Obama administration with the opportunity to pursue additional stimulus measures before demanding a reduction in the deficit.
Yields on 10-year notes rose 7 basis points last week to 2.99 percent as higher-than-estimated corporate profits reduced concerns the economy may drop back into recession. Rates on the notes are still down from a high for the year of 4 percent on April 5, according to BGCantor Market Data. Two-year yields ended last week at 0.58 percent. The 10-year yield rose 1 basis point to 3 percent at 10:23 a.m. in New York.
Lowest Since 1955
The last time yields were this low as the economy expanded was in 1955, when Ray Kroc founded McDonald’s Corp. and Bill Haley’s ‘Rock Around The Clock’ topped the music charts. The 10- year note yield averaged 2.65 percent that year, according to monthly data compiled by the Fed, while the economy grew 6.4 percent, consumer prices for the year declined 0.4 percent and the government ran a fourth consecutive budget deficit.
That period has similarities with today in that bank demand for the most easily traded assets helped hold 10-year yields below 3 percent for most of the 1950s, said David Jones, 72, who rose to vice chairman during his 30 years at Aubrey G. Lanston & Co., one of the original primary dealers that trade with the central bank.
It differs in that “we’re coming out of this great crisis,” said Jones, who serves as a consultant from Denver. “You can contrast that with the post-World War II period where economic potential seemed limitless.”
Investor Concerns
Investors are concerned that the recovery will falter more than a year after Obama signed the $787 billion stimulus package and the Fed cut its target interest rate for overnight loans between banks to a range of zero to 0.25 percent. The Obama administration so far has pushed for targeted additional aid, and some economists anticipate the government will be required to enact further stimulus measures.
“Expectations of growth over the next couple of years have indeed come down,” Alan Blinder, former Fed vice chairman, and economics professor at Princeton University, said in a telephone interview. “There is still plenty of fear out there in the world financial markets, which has investors all over the world scurrying into Treasuries, even though they get paid very little.”
Average increases of 100,000 private sector jobs a month this year has been “insufficient to reduce the unemployment rate materially,” Bernanke said before the Senate Banking Committee July 21. The Fed cut its growth outlook as Europe’s fiscal crisis has led to “a broad-based withdrawal from risk- taking in global financial markets,” he said.
Open Letter
Blinder joined Nobel prize-winning economist Joseph Stiglitz and Mark Zandi, chief economist at Moody’s Economy.com, in signing an open letter calling on the government to increase spending to bolster the economy, published July 19 by the Daily Beast website.
“There’s definitely room in the economy” for more stimulus, said Blinder, who worked with Bernanke when he was chairman of Princeton’s economics department from 1996 to 2002.
Critics of U.S. spending plans, such as Wall Street financier Peter G. Peterson, say debt is the biggest threat to Americans’ future well-being. Peterson has committed $1 billion of the fortune he made as co-founder of the New York-based private-equity firm Blackstone Group LP to raising the alarm about the $13 trillion national debt.
The U.S. economy grew at a 2.5 percent annual rate in the second quarter, down from the 2.7 percent in the prior three months, the Commerce Department will report July 30, according to the median estimate of 68 contributors in a Bloomberg survey.
More Optimistic
Equity investors are more optimistic. U.S. stocks rose last week, almost wiping out the Dow Jones Industrial Average’s 2010 loss, after better-than-estimated earnings at companies from United Parcel Service Inc. to Apple Inc. and Ford Motor Co.
Treasury investors would accept more stimulus without driving yields higher “if there’s a credible longer-term plan to cut the deficit,” said Christopher Bury, co-head of fixed- income rates in New York at Jefferies & Co., one of the 18 primary dealers that are also required to bid on Treasury sales.
“The populist view is that the government has essentially saved the banking industry, saved Wall Street, but at what cost,” Bury said. “If they’re going to come back with more stimulus it’s got to be targeted more towards Main Street.”
The Obama administration has said it will target assistance to state governments and small business lending. So far, there are no plans for a broader stimulus program, like last year’s, whose cost the Congressional Budget Office revised to $862 billion in January.
‘Flexibility’
Treasury said in May that it had “flexibility” in financing a budget deficit the Obama administration projected would reach $1.47 trillion this fiscal year, which ends on Sept. 30. In a survey provided to the Treasury before the May auctions, bond dealers predicted a $1.38 trillion shortfall in fiscal year 2010 and a $1.18 trillion deficit in 2011.
The U.S. has already begun scaling back debt auctions, and will end July having sold $173 billion of fixed-coupon notes and bonds compared with $192 billion in April. Demand has risen 18 percent this year to a record high, with bidders offering $2.95 for every dollar of debt sold compared with $2.50 last year, Treasury data compiled by Bloomberg show.
Government debt has returned 5.7 percent this year, the best performance at this point since 1995, according to Bank of America Merrill Lynch indexes. The rally has been led by investors seeking longer-term securities as inflation excluding food and energy prices held at a 44-year low since April. The difference between yields on two- and 10-year notes narrowed to 2.42 percentage points last week from a record 2.94 percentage points in February.
The U.S. budget deficit in 2009 was 9.9 percent of GDP on Sept. 30, the end of the fiscal year, compared with a six-year high of 7.4 percent in Japan. The ratio in Japan peaked at 11 percent in 1998.
Trimmed Forecasts
Fed policy makers trimmed their forecasts for growth and raised unemployment projections at their June 22-23 meeting. For 2011, officials expect growth ranging from 3.5 percent to 4.2 percent, down from 3.4 percent to 4.5 percent, and a fourth- quarter unemployment rate of 8.3 percent to 8.7 percent, up from 8.1 percent to 8.5 percent.
“If we continue to see weaker data I think we can continue to see yields go lower,” said Michael Materasso, co-chairman of the fixed-income policy committee at Franklin Templeton Investments in New York, which oversees $215 billion of bonds. “The concern is if reports come in too weak that it really upsets the equity markets as well as the credit markets. You may have a risk-off trade and it becomes more solely a Treasury rally.”
Global Growth
Geithner said low interest rates show markets want the U.S. to focus on growth instead of agonizing over short-term spending. In his meetings with Group of 20 policy makers this year, the Treasury secretary has pushed for global growth to take priority over concerns in all but the most cash-strapped nations.
The U.S. will eventually need to rein in its deficit, Geithner said in a July 21 interview on the Charlie Rose show. Because that fact is so accepted, markets are not pressuring the U.S. to make the kinds of immediate cuts required in Spain, Portugal and Greece.
“If you look at financial markets, say, look at how much the Treasury is paying to borrow today, there is a lot of confidence, not just of Americans but investors around the world, that we’re going to find the political way to do it,” Geithner said. “There’s no alternative for us. We’ll be able to do that.”
To contact the reporters on this story: Daniel Kruger in New York at dkruger1@bloomberg.net; Rebecca Christie in Washington at rchristie4@bloomberg.net.
To contact the editor responsible for this story: Dave Liedtka at dliedtka@bloomberg.net.
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