Volatility Drop Means Treasuries Steady Into Election
The collapse in price swings of U.S. government debt to a four-year low shows increasing investor confidence that yields will stay at about record lows amid growing competition for a dwindling supply of the safest assets.
Rates may stay steady beyond June, when the Federal Reserve finishes swapping $400 billion of short-term debt for longer- term securities in a program known as Operation Twist, based on a measure of volatility in three-month options for U.S. 10-year interest-rate swaps. The so-called 3m10y swaption rate is about the lowest since June 2007, when the housing bubble burst.
While yields on Treasury due in 10 years or less are below the pace of inflation, demand is at record highs as reports on jobs signal that the recovery may not be as robust as forecast and as Europe’s debt crisis flares again. The International Monetary Fund now says the amount of global assets that investors consider “safe” will shrink by $9 trillion by 2016.
“We have no sellers,” Charles Comiskey, head of trading at Bank of Nova Scotia in New York, one of the 21 primary dealers of U.S. government securities that trade with the Fed, said in a phone interview on April 30.
Investors remain wary of Europe, where Greece, Portugal and Ireland have sought bailouts, and the potential for weaker growth in the U.S., according to Comiskey, who began his career in the debt markets at Morgan Stanley in 1985.
“It’s almost as though the Treasury market’s waiting for the next shoe to drop,” he said.
Declining volatility in Treasuries, stocks and currencies this year come as central banks inject trillions of dollars into the global financial system.
Bank of America Corp.’s Market Risk index, which measures future price swings implied by options on equities, fixed- income, currencies and commodities, fell to minus 0.69 on May 1, the lowest since October 2007 and down from positive 0.28 at the beginning of the year. A negative number means lower-than-normal volatility expectations based on data going back to 2000.
Ten-year Treasury notes rose in each of the past seven weeks, the longest rally since the period ended Dec. 19, 2008. Its yield fell six basis points last week, or 0.06 percentage point, to 1.88 percent in New York, Bloomberg Bond Trader prices show. The benchmark 2 percent security due in February 2022 gained 16/32, or $5 per $1,000 face amount, to 101 2/32.
Yields fell as low as 1.87 percent on May 4 after the Labor Department said payrolls climbed 115,000 in April, the smallest increase in six months. The median estimate of 85 economists surveyed by Bloomberg News called for a 160,000 advance.
Ten-year yields slid as low as 1.82 percent today, the least since Feb. 3 after elections in France and Greece raised concern governments in the region will slow or abandon deficit- cutting plans used to combat Europe’s debt crisis.
The record low yield was 1.67 percent in September 2011, compared with the average over the past 20 years of 4.93 percent.
“You’ve got this economy that can’t get any sustained period of traction,” Mitchell Stapley, the Grand Rapids, Michigan-based chief fixed-income officer for Fifth Third Asset Management, said in a telephone interview. Fifth Third oversees $22 billion in assets.
Investors are hesitant to abandon the safety of Treasuries without further signs of strength in the global economy, especially Europe. The economy of the 17 nations that share the euro will shrink 0.3 percent in 2012 after expanding 1.4 percent in 2011, the IMF said April 17. The Washington-based lender said world growth would slow to 3.5 percent from 3.9 percent.
Economic concerns and tame inflation outweigh a U.S. budget deficit exceeding $1 trillion and an increase in marketable Treasury securities outstanding to $10.4 trillion from $4.34 trillion in mid-2007.
Options on swaps, whose rates historically have mirrored the trend in Treasury yields, also signal that traders see little risk for big swings through the next 12 months, past the November U.S. election between President Barack Obama and likely challenger Mitt Romney.
Normalized volatility on one-year options for 10-year U.S. interest rate swaps, or 1y10y swaptions, reached as low as 85.5 basis points on May 4, the lowest since November 2007. Swap rates serve as benchmarks for investors in many types of debt, including securities backed by mortgages and auto loans.
‘No Longer Useful’
Hedge-fund manager David Einhorn joined investors including Pacific Investment Management Co.’s Bill Gross, the manager of the world’s biggest bond fund, in saying the Fed’s monetary policy is adding to the risk of future inflation and economic disruptions.
The central bank has kept its target rate in a range of zero to 0.25 percent since 2008, and has purchased $2.3 trillion of bonds. The current program, Operation Twist, ends next month.
Our enthusiasm is tempered by “general inflation connected to the Fed’s continued insistence on maintaining an emergency zero percent interest-rate policy, which we believe is no longer useful or effective,” Einhorn, who runs Greenlight Capital Re Ltd. (GLRE), said on a conference call with investors May 1.
Futures traders are hedging against a slump in bonds. The number of contracts hedge funds and other large speculators hold betting on a drop in 10-year note futures prices exceeded wagers on a rise last month by the most since May 2010, data from the Washington-based Commodity Futures Trading Commission show.
The so-called net short position reached 212,127 contracts in the week ended April 3, before retreating to a 144,756 in the period ended May 1.
“While we don’t think Treasury rates are going to spike any time soon, we think with the 10-year yield under 2 percent is definitely at an area of relative unattractiveness,” Michael Materasso, co-chairman of the fixed-income policy committee at Franklin Templeton Investments in New York, said in a telephone interview May 2. The firm oversees $320 billion of bonds.
Yields on bonds in Germany are even lower than Treasuries, with 10-year bunds ending last week at 1.58 percent. In Japan, the equivalent note’s yield was 0.89 percent. Demand is also being fed by banks needing to meet reserve rules under the Dodd- Frank financial-overhaul law in the U.S. and Basel III regulations set by the Bank for International Settlements in Basel, Switzerland, the IMF wrote in an April 18 report.
“People are craving safe assets,” said Yiu Chung Cheung, who sells derivatives at ING Groep NV in Amsterdam, in a telephone interview on April 27. “It’s more about the protection of wealth as opposed to getting a large interest rate return. There will be continued lower yields.”
Investors have bid $3.18 for each dollar of the $719 billion in Treasury notes and bonds auctioned this year, the most since the government began releasing the data in 1992 and on pace to beat the record of $3.04 in 2011.
“There’s actually a shortage of securities,” Chris Ahrens, head interest-rate strategist at primary dealer UBS AG in Stamford, Connecticut, said in an interview April 30. “Higher yields are not in anyone’s base-case scenario.”
The net supply of Treasuries, or gross issuance minus the amount of maturing debt, will fall by an average of about $32.5 billion a month this year, or 30 percent, to $77.3 billion, according to CRT Capital Group LLC In Stamford, Connecticut. Investors will receive an average $99.4 billion of cash monthly from maturing debt, up from $68.1 billion in 2011, CRT said.
Treasury officials lowered their net borrowing forecast for the current quarter last week, reflecting reduced spending and higher issuance of state and local government securities. The department trimmed its estimate for April through June to $182 billion, $19 billion less than anticipated in January. Officials see borrowing of $265 billion in the quarter starting July 1.
“There is absolutely a shrinking supply of safe assets in the world largely because what has happened with European sovereign debt,” said Ajay Rajadhyaksha, head of rates and securitized products research in New York at Barclays Plc, in an interview on May 2. “The safe asset argument will prevent a big rise in Treasury yields, even if the economy improves more than our models are pricing in.”
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