The inability of the U.S. government to reduce record debt and deficits is being rewarded in the bond market.
For all the concern in Washington that the nation is piling on too much borrowing as the deficit exceeds $1 trillion for a fourth straight year, investors are showing insatiable demand for its bonds. They snapped up the 10-year notes sold by the Treasury Department at an auction last week at a yield of 1.855 percent, a record low for that maturity. Trading has slowed to levels last seen before the global financial crisis began in 2007 as money managers sock away the securities.
“Are we likely to get out of this unusually low yield environment anytime soon? I don’t think so,” said David Gerstenhaber, who founded Argonaut Management LP after leaving Julian Robertson’s Tiger Management LLC in the 1990s. While deficits will matter someday, investors’ desire to preserve the value of their capital is capping yields, he said.
“Right now there seems to be more than enough demand for safe haven assets on the part of fiduciaries who need fixed- income,” Gerstenhaber, whose New York-based firm manages $1.8 billion, said in a May 10 telephone interview.
While the amount of Treasuries outstanding has more than doubled to $10.4 trillion since 2007, a decline in securities globally deemed safe enough to meet tougher bank regulations has made the debt seem scarce. Citigroup Inc. says the pool of “high-quality” debt from the U.S., U.K., Germany and nine other European countries is 72 percent of what it was in 2007.
Yields on 10-year Treasuries, which are benchmarks for everything from mortgages to corporate bonds, fell in each of the last eight weeks, the longest stretch since 1998.
The yield fell as much as seven basis points to a seven- month low of 1.77 percent today. It was six basis points lower at 1.78 percent at 12:31 p.m. New York time, down from this year’s high of 2.40 percent on March 20. The average over the past 20 years is 4.93 percent. The 1.75 percent note due May 2022, which was auctioned on May 9, added 15/32, or $4.69 per $1,000 face amount, to 99 22/32, based on Bloomberg Bond Trader prices.
Even at these low rates investors are showing a greater reluctance to sell the debt. Average weekly trading volume in April among the 21 primary dealers was $495.7 billion, or 4.8 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.
‘Top of the Heap’
“Investors continue to put Treasuries at the very top of the heap” even though “the U.S. budget situation is terrible and the debt burden has risen dramatically and is continuing to do so without any clear solution in view” Robert Tipp, the chief investment strategist for Prudential Financial Inc.’s fixed-income division, said in a May 8 telephone interview. The Newark, New Jersey-based insurer manages $335 billion in bonds.
The continued demand suggests worries about deficits are misplaced, giving President Barack Obama and Federal Reserve Chairman Ben S. Bernanke the flexibility to keep spending to generate sustainable growth.
“We just ultimately need to maintain the confidence of the markets, and we clearly have that today,” Matt Rutherford, the Deputy Assistant Secretary for Federal Finance at the Treasury said in Senate testimony on May 8. “What’s priced into the Treasury market today is that we are going to put together a long-term solution to our debt issues.”
Representatives for Mitt Romney, the former governor of Massachusetts and the co-founder of private-equity firm Bain Capital LLC, didn’t respond to request for comment.
Obama’s 2013 budget calls for boosting debt held by the public to 77 percent of gross domestic product by 2021 from a projected 74 percent in 2012. That compares with an increase to 86 percent for Romney, according to the nonpartisan Committee for a Responsible Federal Budget in February.
Debt would rise under Romney because his budget proposal reduces tax revenue by a greater amount than it cuts spending, the CRFB study found. Obama’s budget leaves the nation’s debt smaller than Romney’s by $246 billion in 10 years, according to the committee’s projections.
The CRFB compares Romney’s budget with what it calls a “realistic baseline” of debt totaling 85 percent of GDP in 10 years. That assumes the extension of policies including tax cuts enacted under President George W. Bush that Obama wants to end for families earning $250,000 or more.
‘We’re Not Greece’
“We have a tremendous amount of debt” and “the only thing that makes it appear to be insurmountable is that you’re dealing with politics,” Michael Materasso, co-chairman of the fixed-income policy committee at Franklin Templeton Investments in New York, which oversees $320 billion of bonds, said in a telephone interview May 10. “The U.S. economy and political system, even though it doesn’t appear that way right now, does have tremendous flexibility. We’re not Greece.”
Bond investors have the ability to push up borrowing costs if they disagree with fiscal policies. Greece, Ireland and Portugal were forced to seek bailouts from the European Union and International Monetary Fund after investors shunned their bonds amid concern their debt and deficits were too high.
Government spending and near zero interest rates have kept the U.S. economy going even as Europe falls back into recession. America’s GDP will expand 2.3 percent this year, according to the median forecast of 75 economists, while Europe’s economic output shrinks 0.3 percent, the median estimate of 41 economists in separate surveys by Bloomberg News.
Krugman Says Borrow
The U.S. should borrow while there is strong demand at low yields to stimulate the economy and return it to its long-term growth-rate trend, according to Nobel Prize winner Paul Krugman and Princeton University professor.
“Right now is not the time to be worrying” about debt levels, Krugman said in a May 1 interview with Charlie Rose. “Slashing spending right now is counterproductive, even from a fiscal point of view.”
Treasury debt outstanding has ballooned from $4.254 trillion in June 2007 as the government borrowed to pay for bailouts of the banking system and programs designed to pull the economy out of recession, including Obama’s $797 billion in stimulus, and extensions for unemployment insurance and tax cuts implemented under Bush.
The last four budget deficits have been the largest in U.S. history, totaling $4.46 trillion. In that time, the 10-year yield averaged 3.35 percent. During the preceding four-year period it was 4.49 percent as deficits totaled $1.14 trillion.
“Markets have given time to the policy makers to come up with a middle road” on spending as long as it’s part of “a viable plan” to reduce deficits in the long term, Eric Pellicciaro, head of global rates investment at BlackRock Inc., said in a May 10 telephone interview. The New York-based firm manages $1.14 trillion in fixed-income assets.
Rather than a referendum on U.S. fiscal policy, rising demand for Treasuries shows investors seeking shelter from global financial turmoil, according to Stuart Thomson, a bond fund manager at Ignis Asset Management in Glasgow, Scotland.
“We consider America to be the best horse in the glue factory,” said Thomson, whose firm oversees $121 billion. “As the world’s reserve asset and the deepest and most liquid global government bond market,” the U.S. “still retains that safe- haven status,” he said.
Treasuries of all maturities returned an average of 38.7 percent, including reinvested interest, since June 2007 and the start of the crisis, according to Bank of America Merrill Lynch bond indexes. That compares with a 1.7 percent loss for the Standard & Poor’s 500 (SPX) stock index when including dividends and a 7.6 percent loss in the ThomsonReuters/Jefferies CRB Commodity Index. (CRY)
When combined with a decreasing supply of high quality debt, pending regulatory and market reforms such as those dictated by the Dodd-Frank financial-overhaul law in the U.S. and Basel III regulations for banks set by the Bank for International Settlements will “increase the price of safety” embedded in assets deemed a reliable store of value, the International Monetary Fund wrote in an April 18 report.
Opposition to Dodd-Frank reforms, including the so-called Volcker rule to limit bets banks can make with their own funds, was dealt a blow on May 10 when JPMorgan Chase & Co. said it lost $2 billion trading synthetic credit securities.
Banks have increased Treasury holdings 5.2 percent since December to $475.8 billion while boosting their stake in mortgage debt sold by government sponsored enterprises Fannie Mae and Freddie Mac 7.4 percent to $1.3 trillion, Fed data show. The combined amount is up from $1.25 trillion in 2008.
Central banks, led by the Fed, have also taken Treasuries out of the market. The Fed has increased its position in U.S. government debt to $1.67 trillion from $475 billion in March 2009 as it undertook two rounds of asset purchases to bolster the economy.
Investors have stepped up bidding at Treasury auctions, offering $3.18 for each dollar of the $791 billion in Treasury notes and bonds auctioned this year, the most since the government began releasing the data in 1992. That compares with $2.50 in 2009, $2.99 in 2010 and the record of $3.04 in 2011.
“We are going to be in this low interest rate environment for some time,” said Tom Tucci, managing director and head of Treasury trading in New York at CIBC World Markets Corp. “Investors just care about getting their money back.”
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