No Love Lost for U.S. Debt as Bond Dealers Share Fewer Treasuries With Fed
The world’s biggest bond dealers are finding fewer Treasuries to sell to the Federal Reserve as its $600 billion purchase program nears an end, a signal of rising demand even as the largest buyer steps away.
The two-week moving average of bond dealers’ submissions for sales to the Fed has fallen 37 percent to $17 billion a day from the $27.3 billion peak offered in November, according to Bloomberg data. Price swings have diminished to levels last seen before the financial crisis began in 2007, helping bonds outperform stocks this month by the most since July.
Demand for government debt is increasing even as the central bank prepares to conclude its purchases, the size of the market has doubled to $9.1 trillion and Republicans in Congress spar with President Barack Obama over the nation’s debt ceiling. By offering fewer bonds to the Fed, dealers are signaling that any rise in yields after the end of so-called quantitative easing will be limited and that Obama faces no impediment to funding the $1.5 trillion budget deficit.
“The Fed’s QE2 program finally appears to be exhausting the supply of Treasuries that can easily come out of investor portfolios, a bullish sign for the market,” said Terry Belton, the global head of fixed-income and foreign-exchange research at JPMorgan Chase & Co., one of the 20 primary dealers who trade debt with the central bank.
The Fed began the second round of asset purchases, known as QE2, on Nov. 10 after buying $1.7 trillion in securities through last year, increasing the amount of money in circulation to prevent deflation. The Fed’s purchases are due to end next month. Dealers have submitted more than $2.4 trillion in Treasuries to the Fed over the past six months.
While QE2 succeeded in avoiding deflation, investors remain concerned about the strength of the economy, which grew at a 1.8 percent annual pace in the first quarter, the slowest rate since the three months ended June 30.
U.S. government securities have returned 1.4 percent in May, including reinvested interest, following a 1.15 percent gain in April, Bank of America Merrill Lynch data show. The Standard & Poor’s 500 Index fell 2.4 percent this month and the Standard & Poor’s GSCI commodity index lost 7.9 percent.
Bonds rose last week, driving the yield on the benchmark 10-year note to as low as 3.05 percent, the least since Dec. 7. The price of the security due in May 2021 increased 19/32, or $5.94 per $1,000 face amount to 100 13/32. Ten-year yields fell seven basis points to 3.07 percent, according to Bloomberg Bond Trader prices. The yield was little changed at 3.06 percent at 1:09 a.m. in New York.
When Yields Rise
Investors should buy Treasuries when yields rise, because the U.S. will grow an average of two percent to three percent for the next few years, said Rick Rieder, chief investment officer of fixed income at New York-based BlackRock Inc., the world’s largest money manager, overseeing $3.45 trillion.
“There is a need for fixed income given the atmosphere,” Rieder said. “Yields are at the low end of the range, but Treasury rates could stay in this low range for years as the economy grinds along.”
Yields on 10-year notes plunged from the high this year of 3.77 percent on Feb. 9 on signs that rising energy and food costs will restrain the recovery from the worst financial crisis since the Great Depression.
The decline should end at 3 percent as U.S. employment improves and QE2 ends, according to William Cunningham, the co- head of global active fixed income in Boston at State Street Global Advisors, which oversees $2.1 trillion.
Payrolls expanded by 244,000 in April, the biggest gain since May 2010, after a revised 221,000 increase the prior month, the Labor Department said May 6. Employment rose by 185,000 jobs in May, according to a Bloomberg survey of economists before the June 3 report.
“If the employment picture keeps chugging along as it is, then it will drag rates higher,” Cunningham said in an interview in New York on May 25. “Yields will gradually go up this year.”
Cunningham expects the 10-year yield to end the year in the 3.5 percent to 3.75 percent range.
Demand for Treasuries has been boosted as regulators try to strengthen the global banking system by requiring financial institutions reduce risks and hold more of the safest assets after about $2.01 trillion in writedowns and losses since the start of 2007. Banks owned a record $1.69 trillion of U.S. government-related debt in the week ended May 4, Fed data show.
Treasuries are in such short supply in the $4.9 trillion-a- day repurchase agreement market used by dealers to finance their holdings that investors are lending cash for next to nothing to obtain the bonds. The average level of overnight general collateral repo rates fell as low as 0.01 percent on May 5. About a third of government securities transactions in the repo market trade below zero percent, according to Barclays Plc data.
Repo rates may move further below the Federal funds rate when the central bank begins lifting borrowing costs. The Fed’s so-called effective rate, a weighted average of trades between major brokers, was 0.09 percent on May 26, according to ICAP Plc data.
“Everybody wants more collateral and Treasuries are the best collateral in the world,” according to Stanford University professor Darrell Duffie, who serves as a member of the Federal Reserve Bank of New York’s financial advisory roundtable.
“You’d think that the world would be awash in Treasuries as the U.S. is issuing more than they ever have,” said Duffie, who studies credit risk, asset pricing and the over-the-counter derivatives as the Stanford Graduate School of Business’s Dean Witter Distinguished Professor of Finance. “But everybody wants them.”
A congressional standoff on raising the country’s debt ceiling has increased demand for bills. Government authorities have curtailed short-term debt sales to conserve borrowing capacity and avoid breaching the Congressionally-mandated threshold of $14.3 trillion.
The reduction has left U.S. six-month bill rates hovering near record lows of 0.005 percent.
Senate Republican leader Mitch McConnell of Kentucky has said his party wants “significant” cuts in spending and no tax increases as a condition for raising the limit. House Speaker John Boehner, a Republican from Ohio, said Congress needs to pair an increase with spending cuts and changes to the nation’s “broken” budget process.
“At some point it’s clear to me that we have to increase the debt ceiling,” Boehner, an Ohio Republican, said May 15 on CBS’s “Face the Nation.” “And as we do, we’re going to do it in a way that addresses America’s long-term fiscal challenges.”
Obama said in a segment for the show taped May 11 in Washington that failing to raise the ceiling may disrupt the global financial system. Treasury Secretary Timothy F. Geithner said he has taken steps to prevent a federal default until Aug. 2, using accounting measures that involve two retirement funds.
So far, there’s been no sign of waning demand for government debt that increased by about 50 percent as Obama boosted spending to pull the economy out of the recession that probably ended in the third quarter of 2009. The Treasury has received $3 in bids for every dollar auctioned this year, up from last year’s record $2.99, Treasury data show. The U.S. has sold $895 billion of notes and bonds this year, compared with $1.003 trillion at this time in 2010.
Treasuries have become more desirable as price swings declined. The Merrill Option Volatility Estimate, or MOVE, index fell to 74.80 basis points on April 25, within 0.7 of its lowest level since July 2007. The index is down from a 12-month high of 125.2 on Dec. 15.
The Fed is responsible for some of the decline. QE2 made it the biggest owner of U.S. government debt, with holdings of $896.7 billion overtaking China’s $895.6 billion in November, according to Treasury and central bank data.
Under the program, the central bank has purchased $675 billion since Nov. 12, mostly from dealers. Fed Chairman Ben S. Bernanke has said he’ll maintain record stimulus until job growth accelerates and the recovery is robust enough to withstand tighter credit.
Inflation is barely eroding the value of fixed-income securities as the recovery slows. The Fed’s preferred measure of price increases, the so-called core inflation reading that excludes food and energy, was 1 percent for the 12 months ended April, the Commerce Department said on May 27.
The Washington-based International Monetary Fund lowered its forecast for U.S. growth this year, predicting the economy will expand 2.8 percent this year, down from the 3 percent projected in January.
“Yields are going to remain around these levels in a range for some time,” said Bret Barker, an interest-rate analyst at Los Angeles-based TCW Group Inc., which manages about $115 billion in assets. “The market is running with the slow growth story right now.”
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