Bloomberg News

Bond Buyers Endorsing Bernanke’s Caution Unfazed by $100 Oil

February 21, 2012

(Updates 10-year yield in sixth paragraph.)

Feb. 13 (Bloomberg) -- The market for U.S. Treasuries is embracing Federal Reserve Chairman Ben S. Bernanke’s view that signs of improving growth mask threats to the nation’s economy, keeping inflation in check.

Traders are betting that government debt yields will remain subdued in the years ahead, even with oil prices stuck at around $100 a barrel. The cost to exchange fixed- for floating-rate payments in a decade has averaged 3.38 percent this year. The so-called forward 10-year swap rate, which has fallen from last year’s peak of 5.47 percent in February, is trading at the same levels as early 2009.

While the U.S. jobless rate fell to a three-year low last month and manufacturing picked up, investors have kept yields on Treasuries near record lows as the Fed lowered forecasts for economic growth and inflation. Bill Gross, who manages the world’s largest bond fund at Newport Beach, California-based Pacific Investment Management Co., has boosted his holdings of U.S. government debt to the highest level since July 2010.

“The market is just not buying that the recent improvement will be sustained,” said Ruslan Bikbov, a fixed-income strategist in New York at Bank of America Corp. “Expectations for lower growth ahead, a shortage of riskless assets and upcoming U.S. fiscal tightening are combining with the fact the Fed is on hold through late 2014 to push forward rates lower.”

Lower Forecasts

Economists are lowering their yield forecasts. The median end of 2012 estimate for 10-year Treasury yields has fallen to 2.48 percent from 2.72 percent in November, according to a survey of 74 economists and strategists surveyed by Bloomberg News. Bank of America sees them at 2.4 percent.

Ten-year Treasury yields were little changed at 1.99 percent at 9:07 a.m. in New York, according to Bloomberg Bond Trader prices. A rise to levels forecast in the survey would still leave yields below the average of 5.28 percent since 1990.

“There is still some benefit to holding long-term Treasuries,” Gregory Whiteley, a money manager focusing on U.S. government debt at Los Angeles-based DoubleLine Capital LP, which oversees $25 billion, said in a Feb. 7 interview. The firm’s Core Fixed Income Fund has returned 12 percent over the past year, beating 99 percent of its peers, according to data compiled by Bloomberg.

Avoiding Bonds

A growing economy combined with record low interest rates has many big investors staying away from bonds. Investors should be 100 percent in equities because of depressed stock valuations and the Fed’s pledge to keep rates low, Laurence D. Fink, chief executive officer of New York-based BlackRock Inc., the world’s largest money manager, said in an interview with Bloomberg Television in Hong Kong on Feb. 8.

The Standard & Poor’s 500 Index has gained 7 percent this year while the S&P GSCI Total Return Index of raw materials has added 3.9 percent.

Warren Buffett, the billionaire chairman of Berkshire Hathaway Inc., said low interest rates and inflation should dissuade investors from buying bonds and other holdings tied to currencies. “They are among the most dangerous of assets,” Buffett said in an adaptation of his annual letter to shareholders that appeared Feb. 9 on Fortune magazine’s website.

Treasuries, except for 30-year bonds, have negative yields after taking inflation into account. Ten-year notes yield about 1 percentage point less than the consumer price index.

Growth, Employment

Gross domestic product is forecast to expand 2.2 percent this year, according to the median estimate of more than 80 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 biggest financial crisis since the Great Depression.

And while the U.S. unemployment rate in January was 8.3 percent, the lowest since February 2009, the percentage of unemployed who have remained without work for 27 weeks or more rose to 42.9 percent from 42.5 percent in December, the Labor Department said Feb. 3.

“It is very important to look not just at the unemployment rate, which reflects only people who are actively seeking work,” Bernanke said at a Feb. 7 hearing before the Senate Budget Committee in Washington. “There are also a lot of people who are either out of the labor force because they don’t think they can find work” or in part-time jobs.

‘Structural Headwinds’

U.S. average hourly earnings rose 1.9 percent in January from a year earlier, the smallest increase since April, and down from 3.2 percent in 2008 and 3.7 percent in January 2009, the Labor Department said Feb. 3.

Slow wage growth combined with still depressed real estate values is making it difficult for Americans to boost their spending, which would contribute to inflation. The government will say this week that the CPI rose 2.8 percent in January from a year earlier, the smallest increase since March, according to the median estimate of 32 economists surveyed by Bloomberg News.

A deficit reduction law passed last year requires $1 trillion in discretionary spending cuts spread over 10 years. The reductions would start in January 2013 if Congress and the administration can’t agree on an alternative plan.

“There are many structural headwinds ahead in terms our economic future,” Pimco’s Gross said in a Feb. 3 radio interview on “Bloomberg Surveillance” with Tom Keene and Ken Prewitt.

Swap Rate Moves

Gross boosted U.S. government and related debt to 38 percent of assets in Pimco’s $250 billion Total Return Fund in January, from 30 percent in December, according to a report on the company’s website Feb. 9. A year ago, Gross had a net bet against Treasuries, and the fund gained 4.16 percent, beaten by 69 percent of similar funds.

The 10-year forward swap rate plunged to as low as 2.56 percent three months after Lehman Brothers Holdings Inc. went bankrupt in September 2008. It reached 5.47 percent in February before moving lower through most of the rest of 2011. It ended last week at 3.47 percent amid concern that Europe’s debt crisis would plunge the world economy back into recession.

Fed policy makers said last month they saw enough signs of weakness in the economy to warrant keeping their target rate for overnight loans between banks between zero and 0.25 percent through 2014, more than a year later than planned.

Fed Wariness

Christopher Low, chief economist at FTN Financial in New York and the only one of 70 analysts in a Bloomberg survey who predicted the 10-year Treasury yield would fall to 2 percent by the end of last year, says the Fed is correct in being wary about the recovery.

“You can make the case that the hiring we are seeing today is a reaction to faster-than-expected growth in the fourth quarter, but it’s also probably not sustainable growth” as much of it came from inventory gains, Low said during an interview with Kathleen Hays and Vonnie Quinn on “The Hays Advantage” on Bloomberg Radio Feb. 7.

Rather than adding to inflation, traders see oil prices hovering at about $100 a barrel, almost 60 percent above the average price of $64 for the past decade, as being a drag on the economy. An extended $10 rise in oil cuts 0.5 percentage point off U.S. growth over two years, according to Deutsche Bank AG.

A measure of traders’ inflation expectations that the Fed uses to help guide monetary policy is at 2.6 percent, down from as high as 3.23 percent last year. The five-year, five-year forward breakeven rate, which projects annualize price increases over a five-year period beginning in 2017, is below its 2.68 percent average since January 2000.

“There doesn’t seem to be any inflation to worry about now,” DoubleLine’s Whiteley said.

--With assistance from Robert Willis and Craig Torres in Washington, Noah Buhayar in New York, Bei Hu and Susan Li in Hong Kong and Wes Goodman in Singapore. Editors: Philip Revzin, Dave Liedtka

To contact the reporter on this story: Liz Capo McCormick in New York at emccormick7@bloomberg.net

To contact the editor responsible for this story: Dave Liedtka at dliedtka@bloomberg.net


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