Worst Month for Treasuries Since 2010 Lures Buyers
Investors from London to Tokyo to Pittsburgh are plowing money back into Treasuries after the biggest decline in 19 months, betting that even an improving global economy won’t ignite a bear market in bonds.
Hedge funds and large speculators raised bullish positions in 10-year Treasury note contracts this month to the highest since March 2008. Yields, which surged to 1.86 percent Aug. 21, sparking the worst investor losses for a four-week period since December 2010, will be little changed by year-end, according to the median forecast of 81 strategists surveyed by Bloomberg.
While employment and retail sales rose last month, U.S. economic growth the next two years will remain below the 3.2 percent annual average since 1948, according to Bloomberg surveys. Subdued inflation, Europe’s debt turmoil, mandated U.S. spending cuts and tax increases after the presidential election, as well as possible Federal Reserve purchases next month are all boosting the allure of bonds.
“We are still in a deflationary, low-growth environment,” Fredrik Nerbrand, global head of asset allocation at London- based HSBC Holdings Plc, said in a telephone interview Aug. 21. “In that environment, Treasuries provide you with stability and a return of capital.”
HSBC increased the allocation of Treasuries to 13 percent of its model portfolio this month from 10 percent and are buying debt with a five-year maturity.
Money managers overseeing about $120 billion raised their holdings of Treasuries this month to 27.6 percent, the highest since 2007 and up from 23.4 percent in April, a Stone & McCarthy Research Associates survey shows. They also kept their duration, a reflection of how long the debt they own will be outstanding, at 100.3 percent of what is contained in benchmark indexes in the week ended Aug. 21, the highest level since October 2010.
The options market’s expectations for the pace of swings in yields remains close to a five-year low reached last month. Normalized volatility on three-month options for U.S. 10-year interest-rate swaps, called 3m10y swaptions, was 77.715 basis points at the end of last week, down from last year’s high of 124.5 basis points in November and back approaching the 71.8 basis points reached on July 23, which was the lowest since June 2007.
Two months after the collapse of Lehman Brothers Holdings Inc. in September 2008, the measure surged to a record high of 221.8 basis points.
Treasury yields rose to 1.86 percent on Aug. 21 from a record low 1.379 percent July 25, translating into losses for investors of 1.6 percent, the most over a four-week period since December 2010, Bank of America Merrill Lynch indexes show.
Yields on 10-year Treasury notes fell 12 basis points last week to 1.69 percent. The benchmark 1.625 percent security due August 2022 rose 1 4/32 week, or $11.25 per $1,000 face amount, to 99 13/32. The gains trimmed this month’s losses in 10-year notes to 1.3 percent from 2.51 percent on Aug. 17.
The yield was 1.64 percent at 2:21 p.m. in New York.
The rise in Treasury yields earlier this month “was viewed as a buying opportunity by some survey participants,” John Canavan, a fixed-income strategist at Princeton, New Jersey- based Stone & McCarthy, said in an interview on Aug. 20.
Benchmark 10-year Treasuries will yield 1.60 percent by the end of September, below June’s projection of 1.90 percent, median estimates in Bloomberg surveys show. The year-end forecast fell to 1.65 percent from 2.1 percent.
Last week’s slide in yields followed the release of minutes from the July 31-Aug. 1 meeting of the Federal Open Market Committee, which signaled policy makers are ready to add to record stimulus unless they are convinced the recovery is accelerating.
The Fed will be “aggressive” and there’s a 50 percent chance it will act next month, Rick Rieder, chief investment officer of fundamental fixed-income at BlackRock Inc., said Aug. 23 on Bloomberg Television’s “In the Loop” with Deirdre Bolton. BlackRock, based in New York, oversees $3.56 trillion, making it the world’s largest money manager.
That means the Fed may add a third round of bond purchases, or quantitative easing, to the $2.3 trillion its bought since 2008. In a letter dated Aug. 22 to California Republican Darrell Issa, the chairman of the House Oversight and Government Reform Committee, Bernanke repeated the statement from the FOMC meeting that the Fed will provide “additional accommodation as needed.”
He has an opportunity to expand on his views in an Aug. 31 speech at the Kansas City Fed’s annual economic symposium in Jackson Hole, Wyoming.
“It’s fairly clear that their finger is really on the trigger of doing QE3,” Franco Castagliuolo, co-manager of the $5.5 billion Fidelity Government Income Fund, said in a Aug. 22 interview. “Whenever the economic data has surprised on the up- side it has turned out to be a false dawn.” Boston-based Fidelity Investments manages $1.5 trillion.
The U.S. economy will probably tip into recession next year if lawmakers and President Barack Obama can’t break an impasse over the federal budget, and if the George W. Bush-era tax cuts expire, according to a report by the nonpartisan Congressional Budget Office published on Aug. 22.
The budget deficit will reach $1.1 trillion this year, according to the CBO. That would be down from last year’s $1.3 trillion, in part because tax revenue has risen by almost 6 percent and spending is down by about 1 percent this year.
This so-called fiscal cliff would cause economic output to shrink next year by 0.5 percent and joblessness would climb to about 9 percent from 8.3 percent if mandated spending cuts of $1.2 trillion over a decade start Jan. 1, the CBO said.
“I don’t expect yields to go higher,” Hajime Nagata, a bond investor in Tokyo at Diam Co., said in an Aug. 21 interview. Economic gains will “be temporary because of the fiscal cliff,” said Nagata, who added to his Treasury holdings this month. Diam, a unit of Dai-Ichi Life Insurance Co., Japan’s second-biggest life insurer, manages about $130 billion.
Fed stimulus will trigger faster inflation and threaten returns for fixed investments, said Tim Price, a money manager who helps oversee more than $1.5 billion at PFP Group LLP, an asset-management firm based in London.
Treasury 10-year yields of even 2 percent don’t compensate for that risk, he said in a telephone interview on Aug. 21.
“The inevitable outcome has to be an inflationary one, maybe not today or tomorrow,” said Price, who is avoiding Treasuries, gilts and bunds, favoring debt of nations such as Qatar and Singapore.
Inflation has held about the central bank’s goal of 2 percent in the two years since Bernanke first suggested he would use asset purchases to boost growth.
Consumer prices in the U.S. were unchanged in July for a second month, with the gain in the index of 1.4 percent over the past 12 months marking the smallest year-to-year increase since November 2010, the Labor Department reported on Aug. 15 in Washington. The core measure, which excludes volatile food and fuel costs, rose 2.1 percent in the 12 months through July.
Gross domestic product is forecast to expand 2.15 percent this year, according to the median estimate of economists surveyed by Bloomberg News. While that’s up from 1.8 percent in 2011, it’s below the average of 3.1 percent in 2004 through 2006, before the start of the worst financial crisis since the Great Depression.
“The U.S. will have continued slow growth in the neighborhood of about 2 percent,” James Kochan, chief fixed- income strategist in Menomonee Falls, Wisconsin, at Wells Fargo Funds Management LLC, which manages $202 billion, said in an Aug. 22 telephone interview. “You are not going to see significant pressure on interest rates anytime soon.”
The Fed has kept its benchmark interest rate for overnight loans between banks in a range of zero to 0.25 percent since December of 2008 and says it expects to keep them low until at least late 2014.
That’s because even as some data has improved, including an addition of 163,000 new workers to the labor force in July, the unemployment rate at 8.3 percent has held above 8 percent since February 2009. Initial jobless claims rose by 4,000 for a second week to reach a one-month high of 372,000 in the period ended Aug. 18, the Labor Department reported Aug. 22.
Hedge funds and other large speculators placed 97,540 more contracts betting 10-year Treasury note prices will rise than that they will fall in the week ending Aug. 21, according to U.S. Commodity Futures Trading Commission data.
Net-long positions rose by 65,204 contracts, or 202 percent, from a week earlier, the Washington-based commission said in its Commitments of Traders report Aug. 24.
“You should not be selling Treasuries and looking for yields to climb significantly higher,” said Mark Dowding, a fixed-income portfolio manager at BlueBay Asset Management in London, which oversees $41 billion in assets, during an interview on Aug. 21.
Political risks remain in the U.S. and Europe.
Republican presidential candidate Mitt Romney said last week that he wouldn’t appoint Bernanke to a third term, while his running mate, House Budget Committee Chairman Paul Ryan of Wisconsin, said on Aug. 23 that he doesn’t want the Fed to provide additional stimulus.
The Republican convention, which was set to begin in Tampa, Florida, today, has been delayed by a day beause of Tropical Storm Isaac. Democrats will re-nominate Obama and Vice President Joseph Biden next week in Charlotte, North Carolina.
“There is some trouble ahead,” said Joseph Balestrino, a money manager who helps oversee $49 billion of bonds at the Pittsburgh-based mutual-fund company Federated Investors Inc. in a Bloomberg TV interview last week.
“The economy has underwhelmed, domestically and internationally,” Balestrino, the firm’s chief fixed-income market strategist, said in an interview with Alix Steel on Bloomberg Television’s “In the Loop” on Aug. 21. “You take cover for a while. I don’t mind buying Treasuries at 1.8 percent on the 10-year.”
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