Bloomberg News

Fed Recovery Doubts Spur Investor Bid for Treasuries

September 24, 2012

Fed Recovery Doubts Spur U.S. Investors’ Bid for Treasuries

Federal Reserve Board Chairman Ben Bernanke during a hearing on Capitol Hill. Photographer: Pete Marovich/Zuma Press

U.S. investors are buying Treasuries at a faster pace than foreigners for the first time since 2010, aiding the government in its efforts to borrow as total public debt outstanding rises above $16 trillion.

Government debt securities held by domestic buyers, excluding the Federal Reserve, rose 10.7 percent in the first seven months of this year to $3.61 trillion, compared with a 6.9 percent increase for countries from China to Germany, according to the latest data available from the Treasury Department and compiled by Bloomberg. Foreign purchases grew 13 percent last year, while U.S. holdings fell 4.6 percent.

Record-low yields are proving no deterrent to U.S. buyers concerned that unprecedented stimulus by the Fed and Chairman Ben S. Bernanke may neither stimulate the economy nor bring down a jobless rate that has exceeded 8 percent since February 2009. The government is dependent on demand for its debt as it seeks to finance a budget deficit poised to exceed $1 trillion for the fourth straight year.

Bonds have “stopped being a total-return market,” Tom Graff, who manages $3.6 billion of fixed-income assets at Brown Advisory Inc. in Baltimore, said Sept. 7 in a telephone interview. “The high degree of uncertainty has caused excess cash to build up among household assets.” As long as individuals are seeking safety rather than being “return- oriented, then no particular yield is too low,” he said.

Falling Share

While investors outside the U.S. own 50.4 percent of outstanding Treasuries, up from 49 percent in May 2011, their share has declined from 55.7 percent in 2008. China, the biggest foreign owner, has cut its holdings to $1.15 trillion from a peak of $1.31 trillion in July 2011.

Foreign holdings of U.S. debt have been cited as a sign of vulnerability by Republicans in this year’s election campaign. Borrowing costs for European nations from Greece to Portugal and Spain surged as nondomestic investors pulled back from their debt markets as deficits soared.

“Does the America we want borrow a trillion dollars from China? No,” Mitt Romney said Aug. 30 in accepting the presidential nomination at the Republican National Convention in Tampa, Florida.

The amount of total U.S. public debt outstanding has risen from less than $9 trillion in 2007 as the government borrows to pay for spending programs designed to help the economy recover from the worst financial crisis since the Great Depression.

Debt, Rates

Even though the national debt has soared, borrowing costs have tumbled as investors sought a haven from the turmoil.

Treasury 10-year yields fell 11 basis points last week, or 0.11 percentage point, to 1.75 percent. That’s down from more than 5 percent in mid-2007. The price of the benchmark 1.625 percent note due August 2022 rose one point, or $10 per $1,000 face amount, to 98 27/32, Bloomberg Bond Trader prices show.

The yield dropped three basis points to 1.72 percent as of 1:35 p.m. in New York.

“There’s that hackneyed phrase that people are concerned about return of principal, not return on principal,” Robert Tipp, the chief investment strategist for the public fixed- income division of Newark, New Jersey-based Prudential Financial Inc., said in a Sept. 19 telephone interview. The division oversees about $350 billion.

Investors have put an average of $16.6 billion per month from September 2011 through July into mutual funds that invest in taxable bonds, according to data from the Investment Company Institute released Sept. 12. That compares with an average monthly outflow of $10.9 billion from stock funds.

Rate Risks

Households increased Treasuries holdings by a record 51 percent in the first half of the year to $878 billion from the end of 2011, according to Fed data released Sept. 20. Mutual funds raised their share by 9.3 percent to $415 billion, while private pensions added 4 percent to $454 billion.

“One of the biggest risks out there is market risk that interest rates will start rising,” Kathleen Gaffney, a money manager at Loomis Sayles & Co., which oversees $171.4 billion, said Sept. 17 in an interview in New York. “You get any kind of traction going on in the economy and those rates are going to move very sharply.”

Gaffney is a co-manager of the $22.4 billion Loomis Sayles Bond Fund (LSBDX:US), which has beaten 97 percent of its peers this year and doesn’t own Treasuries. An investment of $10 million in the current 10-year note would incur a loss of $760,000 should the yield rise to its average during the past five years of 3.07 percent by the end of 2013, Bloomberg data show.

Yield Forecasts

The securities will yield 1.75 percent at the end of this year and may rise to 2 percent by mid-2013, according to the median estimate of 76 economists surveyed by Bloomberg. The poll for May showed yields climbing to 2.7 percent by the mid-2013.

Retail investors might be chasing last year’s returns, said Robert Mecca of Robert A. Mecca & Associates LLC in Hoffman Estates, Illinois. A wealth adviser for about 30 years, Mecca described his clients as ranging from ditch diggers to dentists.

U.S. government debt returned 9.8 percent in 2011, the most in three years, according to Bank of America Merrill Lynch index data. The Standard & Poor’s 500 Index of stocks gained 2.1 percent including reinvested dividends. This year the performance has reversed, with Treasuries returning 1.6 percent and the S&P 500 gaining 18 percent.

“It’s like driving a car by looking through the rearview mirror,” Mecca said in a Sept. 18 telephone interview. “If people are saying, ‘I really am a Treasury bond person, I don’t like what’s going on the world,’ then we say, ‘OK, look into some high-rated corporate bonds.’”

Fed Support

The Fed has supported the bond market by keeping its target rate for overnight loans between banks between zero and 0.25 percent since December 2008 and purchasing $2.3 trillion of securities in two rounds of a monetary policy known as quantitative easing.

Frustrated by the slow pace of the recovery, the Fed announced Sept. 13 that it would likely keep rates at a record low and also said it would inject more money into the economy by purchasing $40 billion of mortgage bonds per month in a third round of QE until the jobs shows “sustained improvement.”

Expansion of America’s gross domestic product is forecast to slow to 2.1 percent in 2013 from 2.2 percent this year, according to the median estimate of economists surveyed by Bloomberg. The unemployment rate dropped to 8.1 percent in August as Americans exited the workforce. The rate hasn’t been less than 8 percent since January 2009.

Rising Purchases

Signs of a global slowdown mean foreign investors aren’t abandoning the safety of U.S. government debt. International net purchases of Treasuries rose to $50 billion in July from $32.4 billion the month before, the Treasury Department said Sept. 18.

Swiss Life Holding AG, Switzerland’s biggest life insurer, said last month the company has reduced its German and French government bond holdings in favor of Treasuries, as the dollar has a “better risk-return profile” than the euro, according to Chief Financial Officer Thomas Buess. China bought Treasuries in July for the first time in three months as the nation’s trade surplus with the U.S. widened by the most on record.

Bond yields may fall further as consumers continue to reduce their debt loads, helping to curb inflation, Gary Shilling, president of A. Gary Shilling & Co. and a Bloomberg View columnist, said in Sept. 20 interview with Tom Keene and Sara Eisen on Bloomberg Radio’s “Bloomberg Surveillance.”

Consumer debt payments fell to 11 percent of disposable personal income as of March, from a peak of 14 percent in 2007, data compiled by Bloomberg show.

Central banks’ stimulus programs aren’t having “any effect on inflation because there’s simply too much supply in the world,” Shilling said. “Deleveraging in the private sector is swamping everything that’s happening both on the monetary and fiscal fronts.”

To contact the reporters on this story: John Detrixhe in New York at jdetrixhe1@bloomberg.net; Daniel Kruger in New York at dkruger1@bloomberg.net

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


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