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Treasury Bears Submit to Fed as Bond Optimism at High

Jay Mueller, who manages $3 billion of bonds for Wells Capital Management in Milwaukee, resisted buying Treasuries for four months, anticipating the Federal Reserve would drop its pledge to keep interest rates at a record low through late 2014.

No more. With the economy growing at a 1.5 percent annual pace, the odds of a recession have risen to 60 percent, making 1 percent yields on 10-year notes a possibility, he said. Wells Capital’s parent, Wells Fargo & Co., boosted its Treasury holdings 32 percent to $11.5 billion in May alone, according to the latest data compiled by Bloomberg.

“We’re in a low-rate environment for a long time, longer than I had thought,” Mueller said in a July 26 interview at Bloomberg headquarters in New York. “I’m finally throwing in the towel.”

So are Pioneer Investment Management Inc., Pacific Investment Management Co., Federated Investors Inc., Northern Trust Global Investments and Columbia Management Investment Advisers LLC. They are adding to holdings of Treasuries as economic growth cools. Of the 20 firms that own the most Treasuries, 16 bought more U.S. government debt during their most-recent reporting periods, Bloomberg data show.

Yield Forecasts

While yields on 10-year Treasury notes climbed two basis points, or 0.02 percentage point, last week to 1.56 percent, they have fallen from this year’s high of 2.4 percent on March 20 and declined from about 2.6 percent a year ago. The benchmark 1.75 percent security due May 2022 declined 5/32 last week, or $1.56 per $1,000 face amount, to 101 22/32.

The 10-year yield declined three basis points to 1.53 percent at 12:33 p.m. in New York.

Yields will be at 1.7 percent by the end of September, down from June’s projection of 1.88 percent, median estimates in separate Bloomberg surveys show. The year-end forecast fell to 1.9 percent from 2.1 percent.

Treasury yields climbed last week as the Labor Department said Aug. 3 that the economy added 163,000 jobs in July, more than the median forecast of 100,000 in a Bloomberg News survey, while the jobless rate rose to 8.3 percent from 8.2 percent. Unemployment has been stuck above 8 percent for 42-straight months.

Gross domestic product expanded at a 1.5 percent annual rate in the second quarter after a revised 2 percent gain in the prior three months, below the average of 2.6 percent since 1982, the Commerce Department said on July 27. Household purchases, which account for about 70 percent of GDP, grew at the slowest pace in a year.

Fed Stimulus

Policy makers led by Fed Chairman Ben S. Bernanke said Aug. 1 they would provide more monetary stimulus “as needed.” The central bank may announce at its September meeting that it will make $600 billion of bond purchases, evenly split between Treasuries and mortgages, to inject cash into the economy, Bank of America Merrill Lynch forecasts.

“When the Fed first said it was going to keep rates low through late 2014 I was like, ‘Oh, come on, how can you possibly know you really want to do that?’” Wells Capital’s Mueller said. He’s now convinced. “They probably are” going to keep rates low that long “and maybe well beyond that,” he said.

Investors in Treasuries are the most optimistic since November 2010, according to a survey published Aug. 1 by Stone & McCarthy Research Associates in Princeton, New Jersey. Holders kept the duration of their bonds at 99 percent of what benchmark measures suggested, the most bullish since the Fed initiated its second round of Treasury purchases, Stone & McCarthy said.

Net Longs

Hedge-fund managers and other large speculators had a net- long position in 10-year note futures for the first time since Jan. 23, and reached a record long bet in two-year note futures for the week ending July 31, according to U.S. Commodity Futures Trading Commission data released Aug. 3.

Speculative long positions in 10-year futures, or wagers that prices will rise, outnumbered short positions by 2,055 contracts on the Chicago Board of Trade. Last week, traders were net-short 77,414 contracts. Bets on higher prices for two-year futures rose 22 percent to 234,808. The previous net-long high was 221,904 contracts in the week ended May 6, 2011.

Even though the 10-year note yields less than the 2.2 percent rate of inflation projected by Treasury rates, investors are seeking them for the safety of principal they offer from global financial turmoil.

‘Reluctant Buyers’

Investors have bid a record $3.17 for each dollar of the $1.255 trillion in debt the U.S. government has sold this year, Treasury data show, up from the previous all-time high of $3.04 set last year.

“Negative real returns don’t make a lot of sense, but given the global turmoil and given liquidity, we are reluctant buyers,” Richard Schlanger, who helps invest $20 billion in fixed-income securities as vice president at Pioneer Investment in Boston, said in a July 30 telephone interview.

Schlanger said he has increased Treasury purchases while paring mortgage-backed securities from government-sponsored enterprises such as Fannie Mae.

It’s not a cheap bet. The term premium, a model created by the Fed that includes expectations for rates, growth and inflation, shows Treasuries are about the most expensive ever.

The gauge reached a record close of minus 1.0187 percent on July 24, meaning investors are accepting yields below what’s considered fair value. It averaged positive 0.8579 percent in the decade before the start of the financial crisis in mid-2007.

‘Too Low’

“Treasury yields are just too low,” said Scott Minerd, chief investment officer of Guggenheim Partners LLC in Santa Monica, California, which has more than $125 billion in assets. “What’s been surprising is that the economy is still moving along, despite the headwinds in the world economy. Yields will likely rise into the year end with risk markets rallying.”

Guggenheim has stopped buying and is waiting for yields to increase to 2-2.5 percent on the 10-year note before buying more, he said.

Bill Gross, who runs the world’s biggest bond fund at Pimco, held 35 percent of the $263 billion Total Return Fund in U.S. government and Treasury debt, the company said July 11 in a report on its website. Gross had eliminated Treasuries from the fund in February 2011 on the expectation that rising deficits would lead to higher borrowing costs.

‘Stimulative Actions’

Central-bank policies led Federated Investors Inc. to buy more Treasuries, Joseph Balestrino, chief fixed-income market strategist and a money manager for the Pittsburgh-based mutual fund company that oversees $49 billion of bonds, said in a telephone interview on Aug. 1.

The company’s Total Return Bond Fund boosted its position in Treasuries to 10.9 percent of its $7.5 billion holdings in June from 7.9 percent in February.

“When you look around the world now you see every monetary authority undertaking a series of stimulative actions,” Balestrino said. “That means every entity almost at once realized growth was not at levels they were comfortable with. A year ago, many of these entities were tightening, or planning on how they would.”

The People’s Bank of China joined the European Central Bank July 5 in cutting benchmark rates, while the Bank of England increased its asset purchases to add cash to the economy. Two weeks earlier, the Fed expanded a program lengthening the maturity of bonds it holds in a program that traders call Operation Twist.

‘Most Liquid’

“We’re stuck in a very low-growth period here and U.S. Treasuries are attractive for a number of reasons, including they are the safest and most liquid market in the world,” Colin Robertson, managing director of fixed income in Chicago at Northern Trust Global Investments, which manages more than $300 billion of bonds, said in an Aug. 3 telephone interview.

Northern Trust increased its Treasury holdings by $2.5 billion, or 37 percent, to $9.2 billion from April to June, Bloomberg data show. “Ten-year rates are going to approach 1 percent in the U.S.,” Robertson said.

Falling borrowing costs are helping President Barack Obama finance a fourth year of deficits above $1 trillion.

The Congressional Budget Office forecasts interest on government debt will equal 1.4 percent of GDP, less than the 3.1 percent when Democrat Bill Clinton ran for re-election in 1996 and 3.2 percent when Republican George H.W. Bush ran in 1992.

Deficit Funding

The Obama administration said July 27 it forecasts the budget deficit will be $1.21 trillion this year, down from $1.33 trillion projected in February. The U.S. faces a so-called fiscal cliff of higher taxes and reductions in spending on defense and other government programs that will take effect at year-end unless Congress acts.

Congressional leaders said July 31 that they will vote in September on a $1.047 trillion, six-month measure that would keep the government operating after the start of the fiscal year on Oct. 1. That would give lawmakers more time to figure out how to avoid spending cuts and tax increases measured by the CBO at $607 billion, or 4 percent of GDP, due to begin Jan. 1.

“A low-growth and low-employment environment continues, and it’s hard to see that changing in a major way,” said Zach Pandl, an interest-rate strategist in Minneapolis at Columbia Management, which oversees $331 billion. Columbia increased its position in Treasuries to $5.1 billion in May, a 9.5 percent jump, data compiled by Bloomberg show.

“The Treasury market has a lot going for it and it’s not obvious that that will change over the near term,” Pandl said.

To contact the reporters on this story: Daniel Kruger in New York at dkruger1@bloomberg.net; Cordell Eddings in New York at ceddings@bloomberg.net

To contact the editor responsible for this story: Robert Burgess at bburgess@bloomberg.net

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