December 30, 2013, Bloomberg Businessweek
For all the losses on Treasuries this year, demand for U.S. government debt remains stronger than before the financial crisis.
Investors bid for $5.75 trillion of notes in government auctions in 2013, or 2.87 times the amount sold, data compiled by Bloomberg show. That’s the fourth-highest ratio since the Treasury Department began releasing the data in 1993, surpassed only in the past three years as demand peaked at 3.15 times in 2012. Before the Federal Reserve began its unprecedented stimulus in 2008, the bid-to-cover ratio never topped 2.65.
While Treasuries are poised for the first drop since 2009 as the longest-term bonds suffer the world’s deepest declines, the willingness of foreign central banks, insurers and pensions to finance the largest debtor nation may temper a further jump in U.S. borrowing costs. Yields on the 10-year notes rose last week to the highest since 2011 and forecasts imply the Fed will cut its Treasury purchases by more than 50 percent from $540 billion this year after beginning to taper earlier this month.
“You’ve got a lot of natural buyers, you’ve got a lot of reasons why people want to be in the most liquid market in the world, even absent Fed buying,” Brian Edmonds, the New York-based head of interest-rates trading at Cantor Fitzgerald LP, said in a telephone interview on Dec. 19.
Cantor is one of 21 primary dealers, which are obligated to bid at U.S. government debt auctions.
Buoyed by the Fed’s unprecedented bond buying, record demand for Treasuries in the last four years has financed U.S. government spending and deficits that exceeded $1 trillion, enabling the world’s largest economy to recover from the worst financial crisis since the Great Depression.
Since mid-2008, the amount of marketable U.S. debt obligations has more than doubled to a record $11.8 trillion.
Yields on 10-year Treasuries, which surged more than a percentage point this year and reached a high of 3.02 percent last week, are still less than half the average 6.07 percent in the two decades before the credit crisis.
While demand for U.S. debt, ranging from two-year notes to 30-year bonds, in government auctions slipped across all maturities from last year’s record, it remained higher than in any year prior to 2008, based on the bid-to-cover ratio.
Bids for interest-bearing Treasuries outstripped the $2 trillion sold competitively this year by $3.75 trillion, data compiled by Bloomberg show. The bid-to-cover ratio was almost 20 percent greater than the average 2.44 times from 1997 to 2007.
The three-year note had the highest ratio of 3.35, while demand for five-year debt that protects against consumer-price gains, known as Treasury Inflation Protected Securities, was the weakest with a ratio of 2.29, the data show.
Bids for the benchmark 10-year note, used to help set interest rates on everything from car loans to mortgages, exceeded the $264 billion sold in 2013 by 2.71 times. That’s also the fourth-highest on record and eclipsed only in the past three years. Prior to the credit crisis, bids outstripped the amount of 10-year notes sold by an average 2.27 times.
“There’s always going to be those investors that need to invest in fixed income, whether it’s foreign central banks for reserve management, or if it’s pension funds and insurance companies,” Thomas Simons, a government-debt economist at Jefferies Group LLC, a primary dealer, said in a Dec. 27 telephone interview from New York. “I don’t have significant worries about people turning away from auctions just because the Fed is buying slightly fewer Treasuries.”
The Fed announced plans on Dec. 18 to cut its monthly bond purchases to $75 billion from $85 billion. Based on 41 economists surveyed by Bloomberg on Dec. 19, the central bank will pare its purchases by $10 billion in each of the next seven meetings before ending the program in December 2014 as the economy strengthens and joblessness decreases.
The estimates indicate the Fed will purchase $260 billion of Treasuries next year, a 52 percent decrease from this year’s total, data compiled by Bloomberg show.
Debt investors are still clamoring for Treasuries even as they are poised to lose money this year for the only the fourth time since 1978, according to index data compiled by Bank of America Merrill Lynch.
U.S. bonds have slumped 3.4 percent in 2013, which would be the first decline since Treasuries posted a record 3.7 percent drop in 2009. Treasuries due in 10 years or more have plummeted more than 12 percent this year, the deepest loss among the 144 government bond indexes globally compiled by Bloomberg and the European Federation of Financial Analysts Societies.
Yields on the benchmark 10-year note rose 0.11 percentage point to 3 percent last week, Bloomberg Bond Trader prices show. The 2.75 percent note due November 2023 fell 30/32, or $9.31 per $1,000 face amount, to 97 7/8.
Rather than a referendum on America’s credit quality, the bond losses reflect greater confidence in the U.S.-led global recovery and suggest the appeal of Treasuries will diminish further as the Fed scales back, according to Christopher Sullivan, who oversees $2.2 billion as chief investment officer at United Nations Federal Credit Union.
The economies of the U.S., Europe and Japan are all forecast to expand next year, the first time that’s happened since 2010, according to economists surveyed by Bloomberg. The U.S. economy will probably grow 2.6 percent in 2014 and accelerate 3 percent the following year, which would be the fastest in a decade, data compiled by Bloomberg show.
“Global markets are undergoing healing and repair,” Sullivan said in a Dec. 17 telephone interview from New York. “The risk of global contagion emanating from a collapse of one kind or another, it’s not zero but it’s receded quite a bit.”
Sullivan said the firm holds a smaller percentage of Treasuries than their allocation in benchmark indexes.
U.S. government debt is suffering the worst returns versus stocks on record this year. With Standard & Poor’s 500 Index gaining 29.1 percent and Treasuries posting a decline, the 32.5 percentage point gap is the most since at least 1978, data compiled by Bank of America and Bloomberg show.
The strength of the dollar may help to bolster demand from overseas debt investors, who own about 50 percent of the U.S. government’s debt obligations. The dollar has gained this year versus 11 of 16 major currencies tracked by Bloomberg, including the Japanese yen, the Norwegian krone, the Brazilian real and the Canadian dollar.
The greenback is forecast to appreciate against the nine other Group-of-10 currencies next year, extending the best annual gain since 2008. The dollar will appreciate 3.6 percent versus the yen and 7.4 percent against the euro in 2014, according to data compiled by Bloomberg.
With yields on 10-year Treasuries more than doubling since reaching a record-low 1.379 percent in July 2012 and economists anticipating yields will rise to 3.4 percent next year, some measures indicate U.S. debt has become relatively inexpensive.
Inflation, which erodes the value of fixed-income payments, has been subdued in the U.S., potentially bolstering demand for bonds. Adjusted for consumer price increases, yields on 10-year notes are now 1.8 percentage points higher than the 1.24 percent rate of annual inflation last month, the most since June 2010, data compiled by Bloomberg show. As recently as February, real yields were negative.
Versus government debt in Japan, which holds more Treasuries than any foreign nation except China, real yields for the 10-year notes are the highest since 1998.
Demand will depend on “whether the yield advantage and the stable currency continues to attract money into Treasuries,” Jim Vogel, an interest-rate strategist at FTN Financial in Memphis, Tennessee, said in a telephone interview. “I don’t see the story changing that much that would drive people away.”
Based on its term premium, a valuation model used by the Fed that is calculated by using interest-rate expectations, economic growth and inflation, the 10-year note is the cheapest in more than two years. The gauge, which rises as a security becomes less expensive, climbed to 0.62 percent last week.
The gauge has averaged 0.21 in the past decade and was negative as recently as June 18, when the 10-year note yielded 2.19 percent, data compiled by Bloomberg show.
“These rate levels are more attractive than we’ve seen since 2011,” William O’Donnell, head U.S. government bond strategist at RBS Securities Inc., one of the primary dealers that trade with the Fed, said in a Dec. 27 telephone interview from in Stamford, Connecticut. That will drive demand and “temper any back-up from here.”
The decline in bidding at government bond auctions this year was led by the primary dealers needing to comply with Dodd-Frank financial reforms and Basel III banking regulations, as well as greater competition from direct bidders.
Dealers accounted for 46 percent of sales, the lowest since 2010, down from 49.7 percent last year.
Investors who aren’t primary dealers that placed bids directly with the Treasury bought a record 17.7 percent of the government securities this year, exceeding the previous all-time high of 14.4 percent last year. Indirect bidders, an investor class that includes foreign central banks, accounted for 36.3 percent of sales at auctions this year from 35.9 percent last year, Treasury data compiled by Bloomberg show.
“We still like Treasuries” and are buying them when yields rise, Sean Simko, who oversees $8 billion at SEI Investments Co. in Oaks, Pennsylvania, said in a Dec. 20 telephone interview. “You have the opportunity to selectively pick your points and add on to positions.”