Dealers Declining Bernanke Twist Invitation
Wall Street banks are increasingly choosing to hoard their U.S. bonds rather than sell them to the Federal Reserve as speculation grows that a slowing economy and global financial turmoil will only make them more dear.
The world’s biggest bond dealers offered an average of $7.2 billion in Treasuries a day to the central bank in June, down 40.5 percent from a high of $12.1 billion in October, data compiled by Bloomberg show. The amount tendered has fallen even as the dealers almost doubled their holdings of the securities.
While the amount of marketable U.S. government debt outstanding has risen to more than $10.5 trillion, Treasuries are proving scarce in a world where five nations in Europe have sought bailouts, the U.S. economy is slowing again and China is weakening. That means interest rates on everything from mortgages to corporate bonds should remain at about record lows.
“People are not willing to sell Treasuries,” said Thanos Bardas, a managing director in Chicago at Neuberger Berman LLC, which oversees about $89 billion in fixed-income assets, in a June 28 telephone interview. “The data in the U.S. doesn’t look as good. The labor market has lost momentum. There will be more upside left in Treasuries despite the low levels of rates.”
Concern that the economy is losing momentum came July 6, when a Labor Department report showed American employers added fewer workers to payrolls in June than forecast and the jobless rate stayed at 8.2 percent.
The International Monetary Fund will reduce its 3.5 percent estimate for global growth this year on weakness in investment, jobs and manufacturing in Europe, the U.S., Brazil, India and China, Managing Director Christine Lagarde said.
“The global growth outlook will be somewhat less than we anticipated just three months ago,” Lagarde said earlier in a July 6 speech in Tokyo. “And even that lower projection will depend on the right policy actions being taken.”
Treasuries rose last week, pushing 10-year yields down 10 basis points, or 0.1 percentage point, to 1.55 percent, according to Bloomberg Bond Trader prices. The benchmark 1.75 percent note rose 28/32, or $8.75 per $1,000 face value, to 101 26/32 in New York.
The 10-year note yield dropped four basis points today to 1.51 percent at 2:44 p.m. New York time, the lowest in more than a month.
The yield has fallen from this year’s high of 2.4 percent on March 20, and has averaged 3.8 percent the past decade. U.S. debt has returned 2.3 percent this year, including reinvested interest, led by a 6.3 percent gain in 30-year bonds.
Treasuries trail the Standard & Poor’s 500 index (CRY) of stocks, which has returned 9 percent with reinvested dividends, while beating the 6 percent loss posted by the Thomson Reuters/Jefferies CRB Index of raw materials.
“There is a reach for quality in the market,” said Larry Milstein, managing director in New York of government and agency debt trading at R.W. Pressprich & Co., a fixed-income broker and dealer for institutional investors. “The Fed and investors are elbowing each other out of the way, and that process is feeding on itself. We are seeing a crowding out effect as there remains a ton of demand for safe assets.”
The Fed under Chairman Ben S. Bernanke bought $2.3 trillion of Treasury and mortgage-related debt to stimulate the economy. It decided in June to extend a policy known as Operation Twist where it sells short-term securities and uses the proceeds to buy longer-term debt to $667 billion from $400 billion.
Primary dealers submitted offers equaling 2.32 times the $1.0804 billion of securities bought by the Fed today, down from an average ratio of 2.93 since the central bank began the program in October.
At the same time the Fed is trying to obtain Treasuries, the 21 primary dealers have boosted their holdings to $109.2 billion from a net short position as recently as September, according to the central bank. Stockpiles touched a record $136.4 billion on June 6.
As a result the central bank is paying more for less. Dealers pared their offers to sell in each month since March, when they submitted 3.16 times the securities bought by the Fed. The ratio fell to 2.92 in April, 2.82 in May and 2.48 in June.
At the end of May, the Fed was paying 31 cents per $1,000 face amount above intra-day market prices, compared with about 94 cents below in March, according to primary dealer Credit Suisse Group AG. That translates into an extra $312,500 on the purchase of $1 billion of eight to 10-year notes.
By some measures Treasuries are about the most expensive levels ever. The term premium, a model created by economists at the Fed, touched negative 0.947 percent July 6, surpassing the most expensive level ever of negative 0.94 percent set on June 1. A negative reading indicates investors are willing to accept yields below what’s considered fair value.
“The Fed is taking a fair amount out of the market,” Ian Lyngen, a government-bond strategist at CRT Capital Group LLC in Stamford, Connecticut, said in an interview July 3. “With the amount that they are holding, as it gets closer to the end of Twist, it will be difficult to argue that that won’t distort the overall ability for those securities to trade without seeing some type of impact.”
Top-rated securities are in short supply worldwide. The U.S., Germany, Switzerland, Sweden and the U.K. are the only Group-of-10 nations with credit-default swaps trading at less than 100 basis points, the cheapest to insure against default, according to Bloomberg data.
New debt for sale is being snapped up. Bidders offered a record $3.16 for each dollar of the $1.075 trillion of notes and bonds auctioned by the Treasury Department in the first half of the year, a record high, even as yields on 10-year notes fell to all-time lows of 1.4387 percent on June 1.
Average yields on investment and speculative-grade corporate bonds declined to 4.04 percent last week from about 10.5 percent in early 2009, Bank of America Merrill Lynch indexes show. The average rate for a 30-year mortgage dropped to 3.62 percent on July 5 from more than 5.5 percent in 2009, according to Freddie Mac.
Investors don’t see yields moving higher anytime soon. A measure of market expectations of interest rate changes, the Merrill Option Volatility Estimate, or MOVE, index fell to 70.2 basis points on June 28 after peaking at 264.6 basis points in October 2008. It touched 56.7 on May 7, the lowest since 2007.
Demand for bonds has surprised even the most successful investors. Warren Buffett the billionaire chairman of Berkshire Hathaway Inc., in February said in his annual shareholder letter that debt securities and other holdings tied to currencies “are among the most dangerous of assets.” Leon Cooperman, founder of equity hedge fund Omega Advisors Inc., also said in February in a Bloomberg Television interview that bonds will be the worst place for investors to put their money for the next three years.
Many investors failed to anticipate the sluggish recovery. President Barack Obama said the creation of 80,000 jobs in June was “a step in the right direction” though the economy has to grow “even faster.” Republican presidential candidate Mitt Romney called it “another kick in the gut.”
Amid fears of a global slowdown, policy makers at major central banks boosted stimulus measures on July 5 to strengthen their economies.
The European Central Bank lowered its refinancing benchmark to a record low 0.75 percent, while the People’s Bank of China reduced its one-year rate for lending by 0.31 percentage point. The Bank of England raised its asset purchase program by 50 billion pounds ($78 billion), to 375 billion pounds.
After cutting its target rate for overnight loans between banks in 2008 to a range of zero to 0.25 percent, the Fed has focused on buying bonds to inject cash into the economy. This has left the central bank as the biggest owner of Treasuries, with $1.67 trillion as of June 27, ahead of China’s $1.15 trillion at the end of the first quarter.
“If the Fed is going to keep this up they will be forced to buy more expensive issues,” said Michael Cloherty, head of U.S. interest rate strategy at RBC Capital Markets in New York, a primary dealer, in a telephone interview July 3. “If you think the Fed is going to have to buy some issues very aggressively it makes it difficult to be short, so you are very reluctant to sell a large block of that to anyone.”
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