QE2 Working Combines With Eisenhower Yields in 1% Returns for Treasuries
Wall Street’s biggest bond-trading firms say investors in U.S. government debt will barely break even next year as yields climb from the lowest levels since the 1950s and the Federal Reserve boosts economic growth.
Investors buying benchmark 10-year notes will gain about 1 percent in 2011 once interest payments are re-invested, as the yield rises to 3.65 percent after averaging 3.2 percent in 2010, according to a Bloomberg News survey of the Fed’s 18 primary dealers. Bank of America Merrill Lynch’s U.S. Treasury Master index returned 8.15 percent annually since its start in 1978.
Average yields on 10-year notes are already the lowest since 1956, when Dwight D. Eisenhower was president, according to “A History of Interest Rates” by Sidney Homer and Richard Sylla and data compiled by Bloomberg. Even though bonds declined the most in a year this month, the dealer estimates show Wall Street anticipates stable inflation as the Fed’s policy of purchasing Treasuries through so-called quantitative easing stimulates growth and demand for riskier assets.
“QE2 has had unforeseen benefits in raising risk appetites and improving confidence across the board,” said Mark MacQueen, a partner at Austin, Texas-based Sage Advisory Services, which oversees $9.5 billion. “At best it’s going to be a mediocre year, but not negative” for Treasuries, he said.
Treasuries have returned 5.28 percent this year even after December’s 2.39 percent drop, according to Bank of America Merrill Lynch data. That compares with a loss of 3.72 percent last year and a gain of 14 percent in 2008, when investors worldwide sought U.S. government debt as a refuge during the financial crisis.
Ten-year note yields rose four basis points, or 0.04 percentage point, to 3.43 percent as of 12:23 p.m. in London. The price of the 2.625 percent security maturing in November 2020 fell 10/32, or $3.125 per $1,000 face amount, to 93 10/32.
The average 10-year yield was the lowest this year since Elvis Presley first entered the music charts with “Heartbreak Hotel” and Eisenhower defeated Adlai Stevenson for a second term. Rates reached a 2010 high of 4 percent on April 5 and dropped as low as 2.33 percent on Oct. 8.
The average 3.07 percent rate in 1956 accompanied economic growth of 1.8 percent, consumer price gains of 3 percent and an unemployment rate that fell to 4.1 percent. In 2010’s third quarter, the U.S. expanded at a 2.6 percent pace, the Commerce Department said Dec. 22. Inflation rose at a 1.1 percent annual rate in November, while unemployment climbed to 9.8 percent.
U.S. growth will slow to 2.6 percent next year from 2.8 percent in 2010, according to the median estimate of 69 economists in a Bloomberg News survey. The consumer price index is forecast to rise 1.5 percent, a separate survey showed.
Europe’s sovereign debt crisis and prospects for subdued inflation make Treasuries attractive, according to Gary Pollack, who helps oversee $12 billion as head of bond trading at Deutsche Bank AG’s private wealth management unit in New York. Portugal was cut to A+ from AA- on Dec. 23 by Fitch Ratings, which cited a slow reduction in the nation’s current account deficit and a difficult financing environment.
“The Fed is buying through June and the outlook for inflation is rather benign,” said Pollack, who is purchasing Treasuries maturing in four to six years. “There are still question marks about the economy, which will keep growth below trend and support lower yields.”
Demand at Treasury auctions has held near record levels even as bonds fall and the administration of President Barack Obama predicts the fiscal 2011 budget deficit will top $1 trillion for a third consecutive year.
Investors bid about $2.96 for each dollar of Treasuries sold last month, near the $3.19 peak in September and the $2.99 average through November, Treasury data show. The so-called bid- to-cover ratio was 2.5 in U.S. note and bond sales last year.
Primary dealers, who are required to bid at debt auctions, reduced their Treasuries to $30 billion as of Dec. 15, from a 2010 high of $81.3 billion on Nov. 24, according to Fed data. That suggests they’re confident the U.S. will avoid falling back into a recession, said Jason Brady, a managing director at Thornburg Investment Management in Santa Fe, New Mexico, which oversees about $72 billion in assets.
“What we’ve gotten is marginally better economic news and that’s made Treasuries a less-favored holding,” Brady said.
Dealers predicted at the end of last year that the median yield on 10-year notes would rise to 4.14 percent in 2010. They were more accurate in 2009, forecasting an increase from the all-time lows reached after the September 2008 bankruptcy of New York-based Lehman Brothers Holdings Inc. froze credit markets.
Goldman Sachs Group Inc., this year’s most accurate forecaster among the dealers, had predicted the yield would end 2010 at 3.25 percent. Morgan Stanley, the most bearish forecaster, said the 10-year rate would rise to 5.5 percent.
James Caron, head of U.S. interest-rate strategy at New York-based Morgan Stanley, now predicts 4 percent by the end of 2011 after acknowledging in August that the firm’s estimates for economic growth and yields were too high.
The Standard & Poor’s 500 Index slid 8.3 percent from the start of 2010 through July 2 on concern the economic rebound was deteriorating. The benchmark index for U.S. equity has since surged 23 percent, bringing the year’s advance to 13 percent, as industrial production, consumer confidence and retail sales signaled the recovery was gaining momentum and investors anticipated the Fed would begin a second round of bond purchases to sustain growth.
Mutual Fund Flows
Investors removed $8.62 billion from U.S. fixed-income funds in the week ended Dec. 15 as bonds fell and stocks rallied, up from a $1.66 billion outflow the week before, the Investment Company Institute said Dec. 22. Bond funds had taken in $234.8 billion through Oct. 31 and $306.7 billion in 2009, according to the Washington-based trade group. Last week’s withdrawals were the largest since the week ended Oct. 15, 2008, when investors took out $17.6 billion.
Bill Gross, who oversees Pacific Investment Management Co.’s $250 billion Total Return Fund, the world’s biggest bond fund, said in October that asset purchases by the Fed probably mean the end of the 30-year rally in bonds. The Newport Beach, California-based firm this month raised its forecast for U.S. growth next year as President Obama agreed to extend current rates for high-income taxpayers for two more years and reduce the payroll tax by $120 billion for one year.
Pimco said in a U.S. Securities and Exchange Commission filing that the fund may invest in equity-linked securities for the first time since 2003.
Even with growth picking up, the central bank will leave its rate for overnight loans between banks unchanged in a range of zero to 0.25 percent through 2011, according to the primary dealers in this year’s survey. Edward McKelvey, senior U.S. economist at Goldman Sachs in New York, said that should help keep yields from surging as growth accelerates.
“The markets will live some of the same issues in 2011 that they had in early 2010, which is perennial expectations that the Fed will tighten,” said McKelvey, who projects 10-year notes will yield 3.75 percent at the end of 2011. “In the end, we don’t see policy changes, but we will have a diet of data that will feed that perception. Our forecast is for strong growth, low inflation and no Fed tightening.”
Primary Dealers Year-End Forecasts for 2011 Firm 2s 10s Fed Funds BNP Paribas 1 3.75 0 - 0.25 Bank of America 1.25 4 0 - 0.25 Barclays Capital 0.8 3.5 0 - 0.25 Cantor Fitzgerald 0.55 3.25 0 - 0.25 Citigroup 0.95 3.65 0 - 0.25 Credit Suisse 1 3.5 0 - 0.25 Daiwa Securities 1.8 4 0.5 Deutsche Bank 0.75 3.25 0.5 Goldman Sachs 1 3.75 0 - 0.25 HSBC Securities 0.6 2.2 0 - 0.25 Jefferies 1.1 5 0 - 0.25 JPMorgan 1 3.6 0.17 Mizuho 0.85 4 0 - 0.25 Morgan Stanley 1.25 4 0 - 0.25 Nomura Securities 1 3.25 0 - 0.25 RBC Capital Markets 1.85 4 0 - 0.25 RBS 1.2 3.5 0 - 0.25 UBS 1 3.5 0 - 0.25 Average 1.053 3.65 0 - 0.25
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