Demand Strong as Ever as Institutions Bid for Bond SalesDaniel Kruger
Demand for new Treasuries from their biggest owners is proving impervious to rising yields and the retreat of Wall Street dealers.
Bids submitted by investors including mutual funds, foreign central banks, pension managers and insurance companies totaled 83 percent of Treasury debt auctioned this year, compared with 84 percent in 2012 and 37 percent in 2008 at the peak of the worst financial crisis since the Great Depression, according to data compiled by Bloomberg.
Consistent demand from investors who control 81 percent of the $11.6 trillion in Treasuries is helping balance declining purchases from bond dealers and individuals in the worst year for government debt since 2009. Yields are rising as the economy improves, the U.S. prepares to refinance a record $1.38 trillion next year, the budget deficit shrinks to the least since 2008, the Federal Reserve plans to reduce its stimulus and Congress battles President Barack Obama over raising the borrowing limit.
“Sovereign wealth funds and central banks are going to continue to have demand for Treasuries,” James Sarni, senior managing partner in Los Angeles at Payden & Rygel, which manages $85 billion, said in a Sept. 17 telephone interview. “Despite the fact there’s widespread concerns that rates are going up, there’s still demand coming from individuals looking for income,” while institutions prize their safety and liquidity, said Sarni, who has been buying high-yield company bonds.
Hedge funds and mutual funds received 20.6 percent of the $13 billion sale of 30-year bonds on Sept. 12, the most since June 2012. That followed their purchase of 29.6 percent of the $21 billion 10-year note offering on Sept. 11 and 20 percent of the $31 billion offering of three-year securities the day before, both six-month highs.
This year they have bought $250.9 billion, or 17.3 percent of Treasuries sold at auction, on pace to surpass the record of 14.4 percent set last year and 2.6 percent in 2008, government data compiled by Bloomberg show.
Investors bid for 2.88 times the $1.521 trillion of notes and bonds sold at Treasury auctions, down from the record 3.11 times the $2.153 trillion sold last year. While the bid-to-cover ratio has fallen for the first time since 2008, demand is the fourth-highest on record going back to 1994. When the U.S. ran budget surpluses from 1998 to 2001, the ratio averaged 2.26 times.
The Treasury received $579.2 billion of direct bids this year and $677.8 billion from indirect bidders, totaling $1.26 trillion. The last time their demand was higher was in 2010 when they bid for 91 percent. In 2008, there were $25.4 billion of direct and $318.1 billion of indirect bids, or 37 percent of the $922 billion of coupon securities offered.
The yield on the benchmark 10-year note fell 15 basis points last week, or 0.15 percentage point, to 2.74 percent as the Fed decided not to trim its $85 billion monthly bond purchases. Yields touched 3 percent last month, up from this year’s low of 1.61 percent in May, as Fed Chairman Ben S. Bernanke said the central bank would consider reducing or ending its stimulus.
The benchmark 10-year yield fell three basis points, or 0.03 percentage point, to 2.70 percent as of 11:56 a.m. New York time, according to Bloomberg Bond Trader data. The price of the 2.5 percent security maturing in August 2023 rose 9/32 or $2.81 per $1,000 face amount to 98 1/4. Yields will end the year at 2.85 percent and rise to 3.10 percent by mid-2014, the median of about 70 analyst estimates in a Bloomberg survey show.
Treasuries of all maturities have lost an average of 2.95 percent this year, according to the Bloomberg U.S. Treasury Bond Index. They are up 0.36 percent this month.
Foreign official holders, including central banks and finance ministries, which make up part of the indirect bidding total, held $4 trillion of Treasuries as of July, up from $1.64 trillion at the end of 2007, government data show.
International demand is being fueled in part by a desire for dollar-denominated assets. The Bloomberg Dollar Index shows the world’s reserve currency has risen 2.7 percent this year, the most in five years.
Many direct bidders don’t want to be identified because of concern that they may suffer repercussions from the 21 primary dealers of U.S. government securities.
Officials at Pacific Investment Management Co. in Newport Beach, California, the world’s largest bond fund manager and which invests about $2 trillion, said while they like direct bidding, Pimco still places most of its auction orders through dealers because they’re better able to handle bids for funds with multiple accounts and custodians.
Pension funds, which need the predictable streams of principal and interest from bonds to pay retirees, as well as insurers who match bond purchases to cover underwriting claims, have been drawn back to Treasuries by the higher yields, William O’Donnell, the head U.S. government bond strategist at primary dealer RBS Securities Inc. in Stamford, Connecticut, said in a Sept. 17 phone interview.
“The flows into bonds will dwarf the Fed’s retrenchment,” John Taft, chief executive officer of RBC Wealth Management U.S.A. in New York, said in a Sept. 17 interview with Tom Keene on Bloomberg Television’s “Surveillance.” Their increasing demand “will keep rates low,” Taft said.
The need for safer assets, including government bonds, will grow by as much as $5.7 trillion by 2020 as the Dodd-Frank Act in the U.S. and capital standards set by the Bank for International Settlements in Basel, Switzerland, require more top-graded debt as loss reserves, the Treasury Borrowing Advisory Committee said in a May 1 report.
The regulations, which discourage risk-taking by financial institutions, are leading dealers to focus on “matching a seller to a buyer and eking out a little bit of the differential between the two rather than assuming risk and then redistributing that risk,” Steve Rodosky, who runs Treasury and derivatives trading at Pimco, said in a Sept. 18 telephone interview.
This year’s losses have been fueled by anticipation that the Fed will reduce its $45 billion in monthly purchases of Treasuries. Individual investors withdrew $79 billion from taxable bond mutual funds since the end of May, according to Investment Company Institute data. Deposits in taxable fixed-income securities jumped 130 percent to $2.85 trillion from 2008 to 2012, according to the trade group.
The sharpest drop in demand for Treasuries has come from the 21 primary dealers, whose bids fell for the first time in five years to 1.93 times the $1.52 trillion sold, compared with 2.13 times in 2012, Treasury data show.
Primary dealer holdings of Treasury securities declined to 1.09 percent of the market from 1.14 percent at the end of 2012. Dealers owned $126.8 billion as of Sept. 11, according to central bank data, the most since April, down from a record $145.7 billion in December. They have held an average of $92.3 billion in 2013, down from $93.1 billion last year.
Fed policy makers last week refrained from reducing the $85 billion pace of monthly bond buying, saying they needs more signs of lasting improvement in the economy.
“Conditions in the job market today are still far from what all of us would like to see,” Bernanke said at a Sept. 18 press conference in Washington after a two-day meeting of the Federal Open Market Committee. “The committee has concern that rapid tightening of financial conditions in recent months would have the effect of slowing growth.”
Republicans in the House of Representatives say they won’t fund the government past Oct. 1 or raise the debt limit by the middle of next month unless money to implement the Affordable Care Act is removed. Obama has said he won’t negotiate over the borrowing cap.
“We’re not going to set up a situation where the full faith and credit of the United States is put on the table every year or every year and a half, and we go through some sort of terrifying financial brinksmanship because of some ideological arguments that people are having about some particular issue of the day,” Obama said Sept. 18 at a meeting of business executives in Washington.
The budget deficit through August was $755.3 billion, the smallest for the period since 2008. The Congressional Budget Office forecasts the shortfall will fall to about $700 billion by the Sept. 30 fiscal year-end from the $1.4 trillion record set in 2009.
“There’s a lot more money chasing fixed-income assets so you have a significant amount of people who always need to be buying bonds,” Ira Jersey, an interest-rate strategist in New York at Credit Suisse Group AG, one of the 21 primary dealers, said in a Sept. 16 telephone interview.
Those buyers include individual investors who want safe investments and central banks who need to hold dollar-based assets because of trade flows, Jersey said. “All of those things have contributed to this demand.”