Bloomberg News

U.S. Paring Debt Sales Vindicates Anti-Austerity Since 2008

July 29, 2013

U.S. Paring Debt Sales Vindicates Anti-Austerity Since 2008

Ben S. Bernanke, chairman of the U.S. Federal Reserve, during his semi-annual monetary policy report to the House Financial Services Committee in Washington, D.C., on July 17, 2013. Photographer: Pete Marovich/Bloomberg

For the first time in three years, the U.S. Treasury will announce plans to begin reducing debt sales in a victory for stimulus over austerity, the majority of Wall Street’s biggest bond dealers say.

Government sales will be cut by $40 billion to $100 billion during the next year when the Treasury announces its quarterly funding needs July 31, a survey of the 21 primary dealers that are obligated to bid at U.S. bond auctions shows. About two-thirds of those responding, including Goldman Sachs Group Inc. and JPMorgan Chase & Co., see reductions this year, possibly as soon as next month. The U.S. issued $2.153 trillion in 2012.

Smaller sales may contain yields as Federal Reserve Chairman Ben S. Bernanke prepares to reduce the $85 billion a month of bond buying that has supported the economy. The budget deficit has fallen to about half what it was in 2009 and a Bloomberg survey shows gross domestic product may grow next year at the fastest pace since 2006. By contrast, the euro area’s economy is shrinking as governments pursue austerity measures in the face of debt turmoil.

“It’s clear the U.S. approach of stimulate first, get the economy running and work on the deficit later has turned out much better than a crackdown of budget deficits now and assuming it will all work out in the long run,” Robert Tipp, chief investment strategist in Newark, New Jersey, for Prudential Financial Inc.’s fixed-income division, said in a telephone interview on July 23 . The group oversees $400 billion.

Reductions Coming

Of 17 companies that provided projections to Bloomberg, 12 said the Treasury would cut sales this year.

Goldman Sachs, JPMorgan, Deutsche Bank AG, Jefferies Group LLC, Citigroup Inc., HSBC Holdings Plc, Societe Generale SA and Cantor Fitzgerald LP forecast smaller auctions will begin in August for securities maturing within five years. Nomura Securities, Barclays Plc, Credit Suisse Group AG, and Royal Bank of Canada expect cuts in the fourth quarter.

Bank of America, Bank of Montreal, Bank of Nova Scotia, BNP Paribas SA and RBS Securities Inc. forecast no drop in issuance this year. Daiwa Capital Markets, Mizuho Financial Group Inc., Morgan Stanley and UBS AG didn’t respond.

The government, which has sold $32 billion of three-year notes each month since October 2010, may reduce August’s offering to $30 billion, Thomas Simons, an economist in New York at Jefferies, said in an e-mail. That would be followed by as much as $2 billion less in sales of two- and five-year notes later that month, he said.

‘No Reason’

RBC Capital Markets expects gradual reductions to begin in the fourth quarter in all maturities under five years, with two-and three-year notes cut by $5 billion and five-year securities trimmed by $3 billion over two quarters, according to Michael Cloherty, the head of U.S. interest-rate strategy in New York for the unit of Royal Bank of Canada.

“There is no reason for them to wait,” Lou Crandall, chief economist at Wrightson ICAP LLC in Jersey City, New Jersey, said July 23 in a telephone interview in reference to the Treasury. “Once upon a time auctions ebbed and flowed from year to year. We’ve had an abnormally long period where we haven’t had that, and we still face long term challenges, but this would be a step back toward a normal path.”

Treasuries Fall

As the U.S. budget deficits topped $1 trillion for four years beginning in 2008 after the worst financial crisis since the Great Depression as the government spent money on bailing out banks and on efforts to jump-start the economy.

To pay for the initiatives, the Treasury sold bonds, with the amount of marketable government debt outstanding rising to $11.4 trillion from $4.7 trillion in 2007. With borrowing needs waning as a growing economy boosts tax revenue, the total has decreased by $21.7 billion since May.

The U.S. Treasury Department said today it will borrow about 6.3 percent less in the July-to-September period than it projected three months ago as a stronger economy and job growth help narrow the nation’s budget deficit.

Issuance of net marketable debt of $209 billion in the July-to-September period compared with $223 billion initially forecast on April 29, after a net paydown last quarter, the Treasury said today in Washington. Borrowing needs for the October-December quarter were estimated at $235 billion. In a statement accompanying today’s borrowing needs, Treasury

Deputy Assistant Secretary for Macroeconomic Analysis Seth Carpenter cited an economy that’s been growing “steadily” for almost four years, a private sector that’s generated jobs for 40 straight months and a stronger housing market.

Economic Outlook

Signs of an economic recovery have damped demand for the safety of U.S. government bonds. The Bloomberg U.S. Treasury Bond Index has fallen 3.3 percent since April 24, and is poised to drop for a third month in a row, the longest losing stretch since October 2012.

Yields on 10-year (USGG10YR) Treasuries, the benchmark for everything from corporate bonds to mortgages, rose as high as 2.75 percent this month from this year’s low of 1.61 percent on May 1. They were little changed at 2.56 percent today after rising eight basis points last week.

Yields on Treasuries have been rising amid comments by Bernanke that the central bank might begin tapering its $85 billion a month in bond purchases if economic growth continues to meet its targets. The selloff in bonds has been the worst since 2009.

The decline has made Treasuries less expensive relative to European bonds. Ten-year U.S note yields are 88 basis points, or 0.88 percentage point, higher than comparable German bunds, about triple the 0.32 percentage point average spread over the past decade. The benchmark security yields 0.24 percentage point more than U.K. gilts, compared with an average gap of negative 0.3 percentage point since 2003.

Relative Value

“Treasuries are very cheap to bunds and almost all comparable European debt,” Jim Vogel, the head of agency-debt research at FTN Financial in Memphis, Tennessee, said in a telephone interview on July 26. “The Fed is still very active in the market buying bonds and that has helped relieve the pressure for yields to go higher.”

The U.S. government and the Fed have both been stimulating the economy. Spending as a percentage of GDP averaged 6.68 percent from 2007 to 2012, about double the 3.88 percent of the euro area. That compares with 2.58 percent for the U.S. in the five years before the financial crisis and 2.48 percent in the euro area, according to data compiled by Bloomberg.

The Fed’s balance sheet assets swelled to a record $3.5 trillion from $856 billion at the start of 2007 as it injected more than $2.3 trillion into the financial system through its bond-buying. It has also held its target interest rate for overnight loans between banks in a range of zero to 0.25 percent since December 2008. By contrast, the European Central Bank has refrained from purchasing bonds and cut its main rate to a new low of 0.5 percent May 2.

Fed View

The Fed has been “a lot more accommodative than other central banks as that has contributed to optimism and why yields are higher versus some of the core European countries,” Brian Edmonds, the head of interest rates trading at Cantor Fitzgerald in New York, said in a telephone interview July 26.

U.S. GDP will grow 1.8 percent this year, 2.7 percent in 2014 and 3 percent the following year, according to the median forecasts of 79 economists surveyed by Bloomberg. Europe has been mired in six quarters of contraction, prompting countries from Italy to Spain to reverse measures to cut spending.

“The U.S. economy is not gangbusters, but we are muddling along in positive territory,” Edmonds said.

Higher tax revenue and lower spending mean the deficit will probably shrink to $378 billion, or 2.1 percent of GDP in 2015, from 3.4 percent next year, 4 percent in 2013 and 7 percent in 2012, according to a Congressional Budget Office report in May.

Deficit Forecast

Smaller deficits may prove to be short-lived as government retirement and medical costs rise, according to the CBO, which forecasts a $798 billion shortfall in 2020.

President Barack Obama faces battles with Congressional Republicans when they return from their August recess over fiscal policy, the $16.7 trillion debt ceiling, and funding the Patient Protection and Affordable Care Act.

“The fiscal situation is only going to get more contentious, and the pain hasn’t really been felt yet” Matthew Duch, a fund manager in Bethesda, Maryland, at Calvert Investments, which oversees more than $12 billion, said in a telephone interview on July 24. “There are many fiscal hurdles, from the debt ceiling to how Obamacare will be dealt with, and the uncertainty is not good for business and growth.”

Fiscal View

The Treasury said in May it might start to issue fewer notes and bonds this year if higher tax receipts and a stronger economy continue to boost revenue.

By comparison, Spanish Prime Minister Mariano Rajoy persuaded the European Commission in May to push back the deadline for bringing his country’s budget deficit in line with European Union limits by two years to 2016.

The 17-nation euro zone is “feeling the effects of austerity,” Adrian Miller, the director of fixed-income strategies at GMP Securities LLC in New York, said in a telephone interview on July 25.

GDP after inflation in the euro area is forecast to fall 0.6 percent in 2013, according to 58 economists surveyed by Bloomberg, after contracting the same amount in 2012, the first two year decline since the euro was introduced in 1999.

“The timing of reduced issuance comes at a good time for the Fed,” Jake Lowery, the money manager for global interest rates in Atlanta at ING Investment Management Americas, which oversees about $120 billion, said in a telephone interview on July 24.

“The Fed has been able to hold the door open for fiscal stimulus, and it has been a positive for the economy,” he said. “Meanwhile Europe’s political willingness to engage in more cost-cutting has waned.”

To contact the reporters on this story: Cordell Eddings in New York at ceddings@bloomberg.net; Jeff Marshall in New York at Jmarshall75@bloomberg.net

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


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