By Liz Capo McCormick and Daniel Kruger
Oct. 19 (Bloomberg) -- Investors can’t get enough Treasuries even as the U.S. budget deficit climbs beyond $1 trillion, the government sells a record amount of debt and the dollar declines to the weakest level since August 2008.
Foreign buyers increased their holdings for a fourth consecutive month in August, to an all-time high of $3.45 trillion, according to Treasury Department data released Oct. 16. U.S. demand is being spurred by a rising savings rate and concern the economic recovery may falter. Fixed-income funds have attracted 18 times more money than stock funds this year, according to data compiled by Morningstar Inc. and Bloomberg.
Bond investors see no reason to abandon Treasuries with the Federal Reserve likely to keep interest rates on hold until at least the second half of 2010. The 15 percent drop in Intercontinental Exchange Inc.’s U.S. Dollar Index from its high this year on March 4 means international investors can buy U.S. debt more cheaply without worrying that speculation about interest rates will boost volatility and erode returns.
“The same yield is more attractive” to foreigners because of the weaker greenback, said Todd White, who oversees government debt trading in Minneapolis at RiverSource Investments, which manages $90 billion of bonds.
International investors owned $3.45 trillion of Treasuries in August, up from $3.08 trillion in December. China, the biggest foreign holder of U.S. government debt, with $797.1 billion, shifted purchases from bills to notes and bonds, buying $15.3 billion in so-called coupon securities in August, government data showed. It owned $727.4 billion in December.
‘Most Liquid Markets’
“The U.S. continues to provide one of the deepest and most liquid markets available for investing,” said Wan-Chong Kung, who helps oversee $89 billion as a portfolio manager in Minneapolis at FAF Advisors, a unit of U.S. Bancorp.
Investors outside the U.S. bought 44 percent of the $1.6 trillion of notes and bonds sold by the President Barack Obama’s and Treasury Secretary Timothy Geithner this year, compared with 27 percent of the $631 billion issued at this point in 2008, government figures show. Barclays Plc, one of the 18 primary dealers that trade with the Fed, forecasts issuance to climb to a record $2.1 trillion this year, and $2.5 trillion in 2010.
Rising demand at Treasury auctions has helped to push the yield on the benchmark 10-year note down from this year’s high of 4 percent on June 11 to 3.41 percent on Oct. 16. Indirect bidders, an investor class that includes central banks, bought 47.4 percent of the $20 billion of 10-year notes sold Oct. 7, compared with an average of 32.7 percent for the past 10 sales.
Not So ‘Terrible’
Purchases rose even as after Merrill Lynch & Co.’s Treasury Master Index of U.S. bonds fell 4.46 percent between December and the end of June, the worst first half on record. The index has gained 1.46 percent since mid-year.
The weakening of the dollar is “terrible news for practically all of the rest of the world’s economies,” except the U.S. and China, Harvard University Professor Niall Ferguson said in an Oct. 16 interview on Bloomberg Radio. China, which manages the yuan’s appreciation, will “intervene to make sure the dollar does not weaken” relative to its currency, added Ferguson, author of “The Ascent of Money: A Financial History of the World.”
The greenback will end the year at $1.50 per euro, compared with $1.4857 today, according to the median estimate of 43 forecasters in a Bloomberg survey. Against the yen, the dollar is projected to finish the year at 90 versus 90.98.
‘Settle Down’
Yields on 10-year notes have moved between 3.1 percent and 3.89 percent since June, less than 50 percent of the range in the first half, amid speculation the Fed won’t raise rates before mid-2010. Citigroup Inc. and Societe General SA are among firms advising investors to use options to bet volatility will fall further. Options give the right to buy or sell a security for a certain amount, the strike price, by a given date.
“We are in the camp that the Fed isn’t going to change policy anytime soon, and therefore feel comfortable selling volatility in the fixed-income market to add yield,” said Tim Freeman, head of U.S. equity derivative sales in New York at Capstone Global Markets LLC, which specializes in volatility trading. “The financial system is beginning to settle down and re-capitalize itself. Volatility across asset classes should continue to come under pressure.”
Fed Chairman Ben S. Bernanke and his fellow policy makers cut the target rate for overnight loans between banks to a range of zero to 0.25 percent at the end of 2008. They will keep the target there until August, when central bankers will boost it to 0.5 percent, according to the median estimate of 47 economists surveyed by Bloomberg from Oct. 1 to Oct. 8.
Recession Relapse
U.S. central bankers doubted the durability of the recovery last month and for the first time signaled they were open to increasing purchases of mortgage bonds to prop up the housing market, minutes of the Federal Open Market Committee’s Sept. 22- 23 meeting released Oct. 14 in Washington showed.
Policy makers considered a relapse into recession a bigger risk than a near-term rise in prices, the minutes showed. They predicted “cautious” consumer spending, business investment and hiring. At the same time, they repeated their pledge to keep borrowing costs low for “an extended period.”
“The economic news, while mixed, still portrays an economy which could fall short of people’s expectations,” said Gary Pollack, who helps oversee $12 billion as head of fixed-income trading at Deutsche Bank AG’s Private Wealth Management unit in New York. “The expectations are that growth in 2010 will be less than in the second half of 2009. Inflation is not expected to rise for the near term.”
Pimco Buys Treasuries
The U.S. has lost 7.2 million jobs since the recession began in December 2007, including a 263,000 drop in September payrolls. The difference between yields on 2-year notes and Treasury Inflation Protected Securities of the same maturity, which reflects the outlook among traders for consumer prices through 2011, ended last week at 0.53 percentage point. The rate of inflation rose 2.87 percent on average between 2002 and 2008.
Pacific Investment Management Co., based in Newport Beach, California, and a unit of Munich-based insurer Allianz SE, predicts the economy is in for a sustained period of below- normal growth. Bill Gross, who runs the world’s biggest bond fund at Pimco, bought government-related debt last month and cut mortgage bond holdings to the lowest level since 2005.
He said he was buying longer-maturity Treasuries because of deflation concerns. Gross boosted the $185.7 billion Total Return Fund’s investment in Treasuries, so-called agency debt and other government-linked bonds to 48 percent of assets in September from 25 percent in July, according to Pimco’s Web site. The holdings are the most since August 2004.
Headed Higher
The majority of economists and strategist surveyed by Bloomberg say yields have bottomed and are headed higher. The median of 57 estimates is for the yield on the 10-year Treasury, which helps determined rates on everything from mortgages to corporate bonds, to rise to 4.18 percent by the end of 2010.
The yield would still be less than the average 7.24 percent since 1980.
Increased demand for U.S. debt by banks is also helping keep yields low. The rate of U.S. household savings rose to 5.9 percent in May, compared with 0.8 percent in April 2008.
Buying lower-risk securities, such as Treasuries, allows banks to shore up balance sheets after taking more than $1.6 trillion in writedowns and losses since the start of 2007 by pocketing the difference between overnight borrowing costs and government bond yields.
The spread between the federal funds rate and the 10-year Treasury yield, now at 3.19 percentage points, reached 3.7 percentage points in June, the widest since 2004. The average over the past 20 years is 1.46 percentage points.
Banks Park Cash
Bank holdings of U.S. Treasury and agency securities increased $287 billion, or 25 percent, since the end of 2007 to $1.42 trillion in September, according to Fed data tracked by Bloomberg. In 2006 and 2007, holdings shrunk 2.4 percent to $1.23 trillion.
Even as the Dow Jones Industrial Average rallied last week above 10,000 for the first time in a year, from 6,500 in March, investors have been pouring money into bond funds at a faster pace than stock funds.
A net $254.6 billion was added to bond funds during the first nine months of 2009, compared with $14.5 billion for stock managers, according to Chicago-based Morningstar. Almost $3.45 trillion remains in U.S. money-market accounts, up from about $2.5 trillion in mid-2007, just before the financial crisis intensified, data from Washington-based Investment Company Institute show.
“There is a lot of cash on the sidelines that needs to be put to work with over $3 trillion sitting in money market funds,” said Bret Barker, an interest rate specialist at Metropolitan West Asset Management in Los Angeles, with $25 billion in fixed-income assets.
To contact the reporters on this story: Liz Capo McCormick in New York at emccormick7@bloomberg.net; Daniel Kruger in New York at dkruger1@bloomberg.net
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