Bond Market Backs Obama With Record Demand for New DebtDaniel Kruger
Investors are plowing cash into new U.S. Treasuries at a record pace, making economic growth rather than budget austerity a key issue as President Barack Obama and Mitt Romney face off in November’s presidential election.
Bidders offered $3.16 for each dollar of the $1.075 trillion of notes and bonds auctioned by the Treasury Department this year as yields reached all-time lows, above the previous high of $3.04 in all of 2011, according to data compiled by Bloomberg. The so-called bid-to-cover ratio was 2.26 from 1998 to 2001 when the nation ran budget surpluses.
Even as Romney and fellow Republicans assail Obama for presiding over the increase of U.S. publicly-owned debt to $10.5 trillion from $5.75 trillion in 2009 amid the worst financial crisis since the Great Depression, the bond market is showing growing investor confidence in the safety of dollar assets.
“The perceived stability of the U.S. financial system, where you have an active and aggressive Federal Reserve, and a broad $15 trillion-plus economy means the U.S. is going to continue to be regarded as a deep, liquid, strong area to invest in,” Rick Rieder, chief investment officer of fundamental fixed income at New York-based Blackrock Inc., which manages $3.68 trillion, said in a June 29 telephone interview. “Rates are going to stay low for a long time.”
Yields on 10-year Treasury notes declined three basis points last week, or 0.03 percentage point, to 1.65 percent and have fallen from 1.88 percent at the end of 2011 and this year’s high of 2.4 percent on March 20. The benchmark 1.75 percent security due May 2022 rose 8/32, or $2.50 per $1,000 face amount, to 100 30/32. The government sold $29 billion of seven-year notes at a record low yield of 1.075 percent on June 28.
The 10-year note yield declined seven basis points to 1.58 percent at 2:20 p.m. in New York, according to Bloomberg Bond Trader prices.
The 3 percent return on Treasuries in the second quarter exceeded the 2.25 percent return on company debt and the 1.11 percent gain for mortgages, according to Bank of America Merrill Lynch bond indexes. The S&P 500 stock index dropped 3.3 percent last quarter while the Thomson Reuters/Jefferies CRB Index of raw materials fell 7.9 percent.
Demand for new issues from the U.S. Treasury has accelerated as investors seek assets in the world’s reserve currency. The dollar has gained 6 percent against the euro and 2 percent against the British pound since the end of March as Europe’s sovereign debt crisis worsened, the U.K. entered another recession and U.S. growth cooled.
Risk-adjusted returns, which account for volatility, show Treasuries topped other major sovereign debt markets including Germany, the U.K., Japan, Canada and Switzerland, data compiled by Bloomberg show. The dollar had the second highest risk-adjusted return after the Japanese yen since March 31.
The dollar is a “haven and if you’re going to buy dollars you’re by and large going to be investing in Treasuries,” James Kochan, chief fixed-income strategist in Menomonee Falls, Wisconsin, at Wells Fargo Funds Management LLC, which manages $232 billion, said in a June 28 telephone interview. “They’re really one and the same trade.”
Even as the bond market rallies, politicians have made reducing the budget deficit a top issue for November’s election. Obama and Republican challenger Romney have each pledged to cut spending with the budget deficit poised to exceed $1 trillion for a fourth year and debt rising to 69.4 percent of gross domestic product from 37.5 percent in 2008.
Romney has slammed Obama for expanding borrowing to fund budget deficits, a $787 billion fiscal stimulus package and loans to General Motors Co. and Chrysler Group LLC, likening the rise in U.S. debt to a prairie fire visible in the distance.
“You don’t say, ‘I’m going to go to bed, because the wind might change,’ you instead look for someone that says, ‘I’m going to take responsibility and fix this -- put it out,’” Romney said on May 16. “It’s high time that we have a president that will stop this spending and borrowing inferno, and I will.”
The government’s budget deficit through May was $844.5 billion, the smallest at this point in the fiscal year since Obama has been in office. The shortfall was $1.3 trillion in fiscal 2011 ended Sept. 30.
The decision by the Fed and Chairman Ben S. Bernanke to hold borrowing costs at about zero since December 2008 combined with $1.3 trillion of bond purchases helped to reduce government and private sector borrowing costs. Interest expense on the deficit was 3 percent of the economy in fiscal 2011, down from 4 percent in 1999, according to data compiled by Bloomberg.
The bid-to-cover ratio has risen from $2.50 during Obama’s first year in office in 2009. The ratio was $2.99 in 2010, data compiled by Bloomberg show.
Rising demand for government debt has pushed down borrowing costs for companies and individuals. Average yields on investment and speculative-grade corporate bonds fell to 4.23 percent last week from more than 5.65 percent in early 2010, based on Bank of America Merrill Lynch indexes. The average rate for a 30-year mortgage has fallen to 3.66 percent from more than 5.5 percent in 2009, according to a Freddie Mac survey.
Investors are hanging on to dollar assets. Average weekly trading volume since April among the 21 primary dealers was $530.8 billion, or 5.1 percent of the amount outstanding. That’s down from $649 billion in June 2007, or 15 percent of the $4.3 trillion outstanding. Back then, the 10-year note yield reached 5.32 percent.
By some measures, Treasuries are overvalued. The term premium, a model created by economists at the Fed, was negative 0.86 on June 26, near the record low of negative 0.94 on June 1. A negative reading indicates investors are willing to accept yields below what’s considered fair value.
An investor buying the current 10-year note would lose 7 percent, including interest, if the yield rose to the 2.5 percent median estimate of more than 60 economists and strategists surveyed by Bloomberg by mid-2013.
“One of the ideas that the market is very complacent about is that rates could actually go up,” said Kathleen Gaffney, co-manager of the $20.9 billion Boston-based Loomis Sayles Bond Fund, in a June 28 telephone interview. “When they move, they move very fast.”
A lasting solution to Europe’s debt turmoil might send rates up. Global stocks jumped, with the MSCI All-Country World index soaring 3.03 percent on June 29 after a meeting in Brussels of EU leaders ended with officials paving the way for cash-strapped financial institutions to tap Europe’s bailout fund directly once they establish a single banking supervisor.
Yields on Italy’s 10-year bonds tumbled 38 basis points to 5.82 percent, while those in Spain plunged 61 basis points to 6.33 percent.
For all the progress, it might take several months or a year to implement the plans, according to German Chancellor Angela Merkel, and may not be enough, said Italian Prime Minister Mario Monti. Two rescue funds, the European Financial Stability Facility and the yet-to-start European Stability Mechanism, may only amount to about 20 percent of the debt of Italy and Spain.
“As long as Europe continues to make headlines with its bailout process, which is taking much longer than the market would like it to, we should continue to see a bullish underpinning to Treasuries from that flight to quality dynamic,” said Ian Lyngen, a government bond strategist at CRT Capital Group LLC in Stamford, Connecticut, in a June 26 telephone interview.
Obama said June 8 that the slowing European economy was dragging down U.S. growth. Gross domestic product in the U.S. rose 1.9 percent in the first quarter, reflecting an increase in consumer spending that now shows signs of cooling as the labor market weakens, the Commerce Department said June 28.
The median forecast of 70 economists in a Bloomberg survey is for 2012 growth of 2.2 percent, below the 2.7 percent average from 2002 to 2007. The Fed has cut its projections for 2013 six times since January 2011. That level of expansion won’t be robust enough to cut an unemployment rate that has remained above 8 percent for 40 months before next year, according to the central bank’s forecasts.
The economy faces the prospect of diminished fiscal stimulus, with $1.2 trillion in automatic federal spending cuts poised to take effect at year-end.
“Investors have generally looked through the fiscal cliff” of expiring George W. Bush tax rates and mandatory spending cuts, as well as “the deficit position and overall debt issues with respect to the U.S,” Christopher Sullivan, who oversees $1.9 billion as chief investment officer at United Nations Federal Credit Union in New York, said in a June 29 telephone interview. “The first choice among investors in terms of flight-to-quality or safety is the U.S.”
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