Treasuries Not Meeting Demand as AAA Debt More Expensive
While Treasury 10-year (USGG10YR) note yields approach record lows, they’re cheap compared with AAA debt of other nations, helping trigger record demand at U.S. bond auctions even in a fourth year of $1 trillion budget deficits.
Yields on the benchmark security are 23 basis points higher than the average for comparable debt of nations from Germany to Australia, above the average of 12 basis points in the past year, data compiled by Bloomberg show. The gap between U.S. notes and German bunds widened to 37 basis points. As recently as November, bunds yielded 34 basis points more than Treasuries.
“Looking at the spectrum of opportunities in safe-haven assets, yields in 10-year Treasuries don’t really look that bad,” Gregory Whiteley, who manages investments in government debt at Los Angeles-based DoubleLine Capital LP, which has $35 billion in assets, said in a May 25 telephone interview.
Even after boosting the amount of marketable debt outstanding to more than $10 trillion from $4.34 trillion in mid-2007, the Treasury Department is attracting record demand at auctions. The cost to President Barack Obama’s administration of financing a fourth straight deficit has never been lower. The extra yield investors receive for holding Treasuries is an added benefit for investors seeking a haven from Europe’s sovereign debt turmoil.
“There is no floor” for Treasury yields, Whitely said. “We could go to 1.50 (percent) this summer and Europe will be the driving force behind it.”
While 10-year yields rose 1.5 basis points last week, or 0.015 percentage point, to 1.74 percent, they are down from this year’s high of 2.40 percent on March 20. The 1.75 percent note due May 2022 declined 1/8, or $1.25 per $1,000 face amount, to 100 3/32 in the five days ended May 25, based on Bloomberg Bond Trader prices. The yield fell three basis points to 1.71 percent at 1:16 p.m. in New York.
Treasury yields dropped 85 basis points since Standard & Poor’s stripped the U.S. of its AAA rating in August 2011 for failing to reduce the deficit amid political wrangling. Rates touched 1.69 percent on May 17, the lowest this year and approaching the record 1.67 percent set on Sept. 23.
Moody’s Investors Service and Fitch Ratings kept their top grades on the U.S., albeit with “negative” outlooks.
Investors have bid $3.19 for each dollar of the $903 billion of notes and bonds sold by the U.S. this year, above the record $3.04 in all of 2011, data compiled by Bloomberg show.
Top-rated assets 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, down from eight a year ago, according to data compiled by Bloomberg.
Bank of America Merrill Lynch’s AAA Rated Global Fixed Income Index contained 3,597 securities with the highest ratings as of April 30, down from a high of 5,331 in December 2007 and the fewest since November 2005. AAA debt assets have returned about 2.18 percent, including reinvested interest, according to the index. Ten-year Treasuries have gained 2.53 percent.
Rising demand for U.S. debt has narrowed the gap with some European issuers. Finland’s 10-year yield is 8 basis points less than Treasuries, compared with an average premium of about 32 basis points in the last 12 months. Those in the Netherlands (GNTH10YR) are 7 basis points higher compared with an average 31 more during the period.
European Union leaders tied their next steps on the financial crisis to the outcome of a contested election in Greece that may determine whether the 17-nation euro currency splinters. EU officials closed their summit meeting May 24 by asking Greek voters on June 17 to elect a pro-austerity government that will make the budget cuts needed to keep the country in the euro.
The currency dropped to the weakest level against the dollar since July 2010, and has fallen more than 5 percent this month. It slid to $1.2496 on May 25 after closing April 2 at $1.3321. The euro weakened to $1.2461 today in New York, the least since July 2010.
“You’ve seen a developing trend toward weakness in the euro-dollar exchange rate, and that partly reflects investors who had taken safe haven in the European core actually moving some of that into the U.S. as a means of diversification,” Carl Lantz, head of interest-rate strategy in New York at Credit Suisse Group AG, one of the 21 primary dealers that trade with the Federal Reserve, said in a May 21 telephone interview.
Higher-rated European sovereign debt, particularly Germany, has remained in demand from Asian reserve managers and sovereign wealth funds, which has been a bulwark holding down yields, according to Stuart Thomson, a bond fund manager at Ignis Asset Management in Glasgow, Scotland.
“The outlook for the dollar is greater than the outlook for the euro at the moment,” Thomson, whose firm oversees $121 billion, said in a May 24 telephone interview. “Investors will find that attractive from a 12-month view. In time the reserve managers will follow that.”
Higher U.S. yields in part reflect an outlook for faster growth than in Europe. America’s gross domestic product will expand 2.3 percent this year, according to the median forecast of 74 economists, while Europe’s economic output shrinks 0.35 percent, the median estimate of 32 economists in separate Bloomberg surveys show.
Treasury yields were 38 basis points higher than the average of top-quality sovereign debt on April 3, after minutes from the Fed’s March 13 meeting signaled the central bank was unlikely to initiate an additional round of monetary stimulus.
Since then, the odds of Fed policy makers announcing additional easing at their June 20 meeting have risen to about 50-50, Morgan Stanley economists, led by Vincent Reinhart wrote in a May 18 note to clients.
“To buy Treasuries you have to buy U.S. dollars,” Jack McIntyre, a fund manager who oversees $28.5 billion in debt at Brandywine Global Investment Management in Philadelphia, said in a May 25 telephone interview.
“The dollar’s proven itself to be the flight-to-quality beneficiary in this environment” rather than the yen or the franc, which have been sold by the Bank of Japan and the Swiss National Bank to prevent their gains from undermining their economies, he said.
U.S. government debt may also benefit from a slowdown caused by the expiration of George W. Bush-era tax cuts at the end of the year, while bunds may be hurt by “the contingent liability aspect” of expectations that Germany will have to provide funding for additional rescues in Europe, McIntyre said.
The Treasury sold $35 billion of two-year notes May 23 at a yield of 0.30 percent with a 0.25 percent coupon, garnering $3.95 in bids for every dollar of debt sold, the second-highest demand since 1992 when the government began collecting the data.
Even with the demand, the U.S. couldn’t match Germany, which sold 4.56 billion euros ($5.72 billion) of two-year notes the same day at a 0.07 percent yield, an all-time low, according to the Bundesbank. Japan sold 2.495 trillion yen ($31.4 billion) of two-year notes on April 26 to yield 0.11 percent.
“We have bunds joining Japan in that super low-yielding group,” Robert Tipp, chief investment strategist in Newark, New Jersey, for Prudential Financial Inc.’s fixed income division, which oversees $335 billion in bonds, said in a May 23 telephone interview. “Investors look and see Treasuries and have to bring them along as a result of this move.”
The flight to quality is divided, with European investors buying bunds and everyone else favoring Treasuries, said Jim Vogel, head of agency-debt research at FTN Financial in Memphis, Tennessee, in a May 23 telephone interview.
“The question isn’t ‘I’m necessarily afraid of a bad outcome in Europe,’” Vogel said. “It’s ‘I don’t know how it gets better and so I need to reduce my exposure to Europe until I can make a sensible choice.’”
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