Treasury Scarcity to Grow as Fed Buys 90% of New Bonds
Even as U.S. government debt swells to more than $16 trillion, Treasuries and other dollar fixed- income securities will be in short supply next year as the Federal Reserve soaks up almost all the net new bonds.
The government will reduce net sales by $250 billion from the $1.2 trillion of bills, notes and bonds issued in fiscal 2012 ended Sept. 30, a survey of 18 primary dealers found. At the same time, the Fed, in its efforts to boost growth, will add about $45 billion of Treasuries a month to the $40 billion in mortgage debt it’s purchasing, effectively absorbing about 90 percent of net new dollar-denominated fixed-income assets, according to JPMorgan Chase & Co.
Even after U.S. public borrowings outstanding grew from less than $9 trillion in 2007 as the U.S. raised cash to pay for spending programs designed to pull the economy out of the worst financial crisis since the Great Depression, rising demand coupled with a drop in net supply means bonds will be scarce.
“The shrinking amount of bonds in the market is lowering rates and not just benefiting the Treasury, but providing lower rates for private-sector decision-makers as well,” Zach Pandl, a senior interest-rate strategist in Minneapolis at Columbia Management Investment Advisers LLC, which oversees $340 billion, said in a Nov. 30 telephone interview. “The Fed is not creating this scarcity to help out the Treasury, it’s primarily to get the economy going.”
Investors bid for more than four times the amount of two- year notes the Treasury auctioned last week, matching a record high, data compiled by Bloomberg show. Yields on U.S. government bonds are about a half a percentage point lower than the rest of the world on average, compared with about a quarter-percentage point more as recently as April 2010, Bank of America Merrill Lynch indexes show.
Buyers range from central banks to financial institutions stocking up on high-quality assets to meet the Dodd-Frank financial-overhaul law and global regulations set by the Bank for International Settlements. They’re helping the Fed and the Obama administration keep borrowing costs at all-time lows for everyone from consumers to Walt Disney Co.
Strategists have cut their forecasts for 10-year Treasury yields. They now see the benchmark yield at 2.26 percent by the end of 2013, down from the 2.79 percent predicted in June, based on the median estimate of about 50 analysts in separate surveys by Bloomberg. The yield has averaged 4.88 percent average since Bill Clinton began his first term as President in 1992.
U.S. 10-year yields fell seven basis points, or 0.07 percentage point, last week to 1.62 percent in New York, according to Bloomberg Bond Trader prices. The yield rose less than two basis points to 1.63 percent at 12:35 p.m. in New York.
Bonds rose as President Barack Obama and Republican lawmakers traded ideas on how to avoid more than $600 billion in mandated spending cuts and tax increased scheduled to go into effect in January.
Obama warned Nov. 30 of “prolonged negotiations,” while U.S. House Speak John Boehner said the administration plan presented to congressional leaders by Treasury Secretary Timothy F. Geithner would risk growth by raising taxes on small businesses.
Programs to pay for the bailout of the financial system, an extension of unemployment benefits and to bolster housing helped caused the size of the U.S. taxable debt market to swell 27 percent since 2007 to $31.3 trillion, according to Nomura Holdings Inc. The figures exclude money-market securities such as commercial paper.
With the economy strengthening, net sales of new U.S. fixed-income dollar debt with maturities of more than a year, such as corporate, sovereign and municipal bonds, will fall next year to $1.121 trillion from $1.344 trillion, or an almost 17 percent drop, according to JPMorgan’s fixed-income research team, led by Terry Belton.
The decline includes a slide in net Treasuries to $893 billion from $1.002 trillion in fiscal 2012, according to JPMorgan in a report dated Nov. 21. Overall, net supply of fixed-income debt will average about $93 billion per month in 2013, the bank estimates, down almost 20 percent.
With the Fed buying about $85 billion a month in Treasuries and mortgage bonds next year, the net supply to the private sector will be about zero as the central bank effectively soaks up about 90 percent of new issuance of those assets.
Gross U.S. borrowing through Treasury sales rose to more than $2.1 trillion in each of the last three years from $922 billion in 2008, according to government data. Debt owned by the public jumped to $10.1 trillion in January 2012 from $5.75 trillion in January 2009.
Even without the full effects of the fiscal cliff, net Treasury sales will slip to $952 billion as the budget deficit contracts to about $918 billion for fiscal 2013, according to the average prediction of 18 primary dealers surveyed by Bloomberg News. The shortfall totaled $1.089 trillion in 2012, a Treasury Department report said Oct. 12, the fourth straight year above $1 trillion.
The smaller net supply of government debt will be matched by fewer corporate issues, according to Nomura. Net company borrowing may fall to $288 billion next year from $353.6 billion, the firm estimates.
Walt Disney (DIS) sold a record amount of debt last week at the lowest interest cost it’s ever paid. The company issued $3 billion of bonds on Nov. 27 in a four-part offering with coupons ranging from 0.45 percent on three-year debt to 3.7 percent for 30-year securities. The issue was the biggest in the 89-year history of the Burbank, California-based company.
The effect on yields from less supply coupled with high demand typically proves temporary, according to Mark Dowding, a senior fixed-income manager at BlueBay Asset Management in London, which oversees $47 billion.
“Considerations like supply and demand are important if you are looking at the shorter term, but for out over a three, six or 12 month period, the most important factor is going to be the economy,” he said in a telephone interview on Nov. 28. “Although negotiations surrounding the cliff may be somewhat difficult, we do expect a compromise to be found and see the 10- year yield more likely to head to 2 percent than to 1.25 percent.”
The U.S. economy expanded more than previously estimated in the third quarter, led by consumer spending, government outlays and residential construction. Gross domestic product rose at a 2.7 percent annual rate for the period from July through September, up from 2 percent reported in October, revised figures from the Commerce Department showed Nov. 29.
Persistent demand for U.S. securities as a haven from turmoil in the world’s financial markets since the subprime mortgage collapse in 2007 and Europe’s three-year-old sovereign debt crisis has helped damp yield increases even as government supply rose.
Foreign governments and banks have been among the biggest buyers. Brazil, Belgium, Luxembourg, Russia, Switzerland, Taiwan and Hong Kong boosted their holdings by a collective $264.8 billion since August 2011, Treasury data released Nov. 16 show.
Yields on Treasuries of all maturities ended last week at 0.897 percent, below the 1.42 percent for the global government bond market excluding the U.S., according to Bank of America Merrill Lynch indexes. In April 2010, U.S. yields averaged 2.44 percent, versus 2.22 percent for the rest of the world.
Deposits at U.S. banks exceed loans by $1.91 trillion, marking a turnaround from 2008, when loans exceeded deposits by about $200 billion. Much of that surplus money has been used to buy Treasuries and government agency debt such as that issued by Fannie Mae, Freddie Mac, boosting holdings to a record $1.86 trillion, Fed data show. Bank holdings of Treasuries increased 15 percent to $531.7 billion in the past year.
Investors have bid a record $3.16 for each dollar of the $1.974 trillion in notes and bonds the U.S. government has sold at auctions this year, Treasury data show, up from the previous high of $3.04 set last year. The bid-to-cover ratio at the Treasury’s auction of $35 billion in two-year notes on Nov. 27 was 4.07, matching the record high in November 2011.
That has kept down the cost of financing the record $16 trillion debt. The U.S. spent $359.8 billion on interest expense in fiscal 2012, below the $454.4 billion the previous year.
Consumers are also benefiting. The average interest rate on 30-year mortgages is a record low 3.31 percent, according to a weekly survey conducted by Freddie Mac. Banks reported the most common rate for a 48-month new-car loan was 4.88 percent in August, the most recent reporting period. The rates were more than 7 percent in December 2008.
The Fed has pumped money into the financial system by purchasing more than $2.3 trillion of Treasuries and mortgage- related securities in three rounds of policy called quantitative easing. The latest program announced Sept. 13 involves buying $40 billion a month in mortgage securities, and has no end date or fixed total amount.
A “number” of Fed officials said the central bank may need to expand its purchases next year, according to the minutes of the Federal Open Market Committee’s Oct. 23-24 meeting. Bond traders predict policy makers will announce at their Dec. 11-12 meeting that they will make new Treasury purchases next year of about $42.9 billion a month, according to the average estimate of primary dealers surveyed by Bloomberg News.
The Congressional Budget Office said that failure to reach an agreement on the fiscal cliff may push the economy into a recession next year and boost unemployment to 9.1 percent in the fourth quarter of 2013, from 7.9 percent in October.
“You’ve got supply likely to come down and you’ve got demand strong,” Brett Wander, chief investment officer for fixed income in San Francisco at Charles Schwab Investment Management Inc., which oversees about $200 billion, said in a telephone interview Nov. 29. “Think of it like arrows acting like forces on an object. The supply arrow is pushing yields down and the demand arrow is pushing yields down at the moment.”
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