Despite downgrade, treasuries due in 10 years or more returned 25.6%.
The US government received record demand for its bonds in 2011, pushing longer-maturity Treasuries to their best performance since 1995 in a sign that President Barack Obama may have little difficulty financing a fourth consecutive year of $1 trillion budget deficits.
The treasury department attracted $3.04 for each dollar of the $2.135 trillion in notes and bonds sold, the most since the government began releasing the data in 1992 during the George H W Bush administration. The US drew an all-time high bid-to-cover ratio of 9.07 for $30 billion of four-week bills it auctioned on December 20 even though they pay zero per cent interest.
While Standard & Poor’s stripped the US of its AAA credit rating on August 5, Treasuries due in 10 years or more returned 25.6 per cent this year. The spreading sovereign debt crisis in Europe and slower global growth are driving investors to the safety of US assets, helping to contain borrowing costs and making it cheaper as a percentage of gross domestic product to finance deficits than when the nation last had budget surpluses.
“If the last two weeks are any indication of how next year will start, there’s near-insatiable demand,” Ira Jersey, an interest-rate strategist at Credit Suisse Group AG in New York, one of 21 primary dealers that are required to bid at the auctions, said in a December 21 telephone interview. “We have a significantly shrinking supply of risk-free assets in the world and US Treasuries are one of the few left.”
Beating commodities, stocks
The last time longer-maturity Treasuries returned as much as this year was in 1995, when they rallied 30.7 per cent. Treasuries were some of the best assets to own this year, returning 8.9 per cent, compared with a decline of eight per cent for the Thomson Reuters/Jefferies CRB Index of raw materials and a 0.6 per cent gain in the Standard & Poor’s 500 Index of stocks. Global sovereign debt and mortgage-backed securities rose 5.8 per cent, and corporate bonds climbed 4.3 per cent, according to Bank of America Merrill Lynch bond indexes.
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The dollar is poised to strengthen for a second straight year against its major trading partners, appreciating 1.2 per cent as measured by IntercontinentalExchange Inc’s Dollar Index. The gauge rose 1.5 per cent in 2010.
“The US is benefiting from a very unstable global environment,” Scott Graham, the head of government bond trading at the Bank of Montreal’s BMO Capital Markets unit in Chicago, a primary dealer, said in a December 21 telephone interview. “At some point you’d think demand would wane if Europe gets settled.”
While yields on 10-year notes rose 18 basis points, or 0.18 percentage point, last week to 2.02 per cent, they are down from 3.3 per cent at the end of 2010, Bloomberg Bond Trader prices show. The rates fell one basis point to 2.01 per cent at 9.17 am London time, and the two per cent security due November 2021 added 1/8, or $1.25 cents per $1,000 face amount, to 99 28/32.
Low yields mean that interest expense accounted for three per cent of the economy in fiscal 2011 ended September 30, down from four per cent in 1999. When the US ran budget surpluses between 1998 and 2001 the bid-to-cover ratio was 2.26.
“Some of the trades that appeared obvious have been wrong,” John Fath, a principal at the investment firm BTG Pactual in New York who manages $2.5 billion of bonds, said in a December 21 telephone interview. “Most people thought if the US was downgraded it would lead to higher rates. Most people argued that increasing deficits would be more difficult to finance.”
Caught off guard
Among those caught off guard by the strong demand for Treasuries was Bill Gross, who runs the world’s biggest bond mutual fund at Pacific Investment Management Co. In February, Gross had a net bet against Treasuries in the firm’s flagship Total Return Fund, which has gained 3.3 per cent this year, ranking in the 28th percentile of similar funds, according to data compiled by Bloomberg.
“This no-Treasury thing is simply a demonstration of vigilance on the part of Pimco that says these bonds aren’t worth what others appear to think they’re worth, and we prefer another menu, that’s all,” Gross said in an April 20 telephone interview.
Government and Treasury debt now make up 23 percent of the $241 billion Total Return Fund, according to data posted on Newport Beach, California-based Pimco’s website December 9.
Gross wasn’t the only one surprised by the performance of Treasuries. The median estimate of 70 economists and strategists surveyed by Bloomberg in early January was for 10-year yields to end this year at 3.75 per cent. FTN Financial had the lowest estimate, at two per cent. For the end of 2012, the median forecast is 2.6 per cent.
Steady decline
Ten-year yields, which are a benchmark for everything from corporate bonds to mortgages, have been on a steady decline since 1981, when they exceeded 15 per cent.
They were at 6.57 per cent in January 1993 at the end of the elder Bush’s presidency, down from 9.54 per cent in early 1989 when he took office as the Fed cut its target rate for overnight loans between banks to three per cent from a high of 9.75 per cent in February 1989 as growth slowed. Yields have averaged 4.92 per cent since Bill Clinton was sworn in as President in 1993.
The worst financial crisis since the Great Depression boosted the allure of Treasuries, as investors sought a haven amid a plunge in the value of higher risk assets such as stocks and corporate bonds. The Fed has kept its target rate in a range of zero to 0.25 percent since December 2008, and has pledged to keep there until mid-2013.
Bid-to-cover ratios at Treasury auctions averaged $2.99 in 2010, up from $2.50 in 2009 and $2.23 the prior year.
Accelerating demand
Demand accelerated toward the end of the year, with investors bidding $3.20 per dollar of securities sold in November and December amid concern that the health of the European economy was deteriorating and that Italy may need a bailout.
The Treasury market has benefited from being one of the only refuges left for investors even as the amount of US government borrowing surpassed $15 trillion. The yen is the only major currency to have outperformed the dollar, rising 4.1 per cent.
“You have a lot of risk-free, high-quality assets globally that are no longer risk-free, in terms of the other global sovereigns,” Christopher Bury, co-head of fixed-income rates at Jefferies & Co, a primary dealer, said in a December 16 telephone interview. “You have more people chasing fewer risk-free assets. Everything points right now in the same direction.”
Rolling returns
US government debt will post its best five-year performance, gaining 39 per cent from the start of 2007, since they returned 45 per cent from 1998 through 2002, a period that included the failure of Long-Term Capital Management LP, the collapse in internet stocks and the September 11 terror attacks.
That’s even as budget deficits have totalled $4 trillion in the three fiscal years from October 2008 through September 2011. The shortfall may narrow to $1.1 trillion in fiscal 2012 from $1.3 trillion in 2011, according to a survey of bond dealers in the minutes of the Treasury Borrowing Advisory Committee’s November 2 meeting.
About 45 per cent of the $7.76 trillion in Treasury notes and bonds will need to be refinanced by the end of 2014, highlighting the importance of continued demand.
“I’m not as concerned” about the ability of the Treasury to attract borrowers “as I am about the economy being self- sustaining,” David Coard, head of fixed-income trading in New York at Williams Capital Group, a brokerage for institutional investors, said in a December 21 telephone interview.
Economic Outlook
The economy will probably expand 2.1 per cent in 2012 and 2.5 per cent in 2013, according to median forecasts in a Bloomberg News survey. The Fed’s forecast is for 2.7 per cent growth in 2012 and 3.25 per cent in 2013.
In addition to keeping its benchmark rate at a record low, policy makers moved on September 21 to contain yields, saying the central bank would buy $400 billion of longer-term government securities and sell $400 billion of short-term debt.
The Fed “still believes that lower rates are good, and it’s going to do all that it can to keep rates down and have them stay there,” Eric Pellicciaro, head of global rates investment at New York-based BlackRock Inc., which manages $1.14 trillion in fixed-income assets, said in a December 16 telephone interview. “They’re not going to settle for trend growth. They want more.”