The Wall Street's biggest bond-trading firms say investors in US government debt will barely break even next year as yields climb from the lowest levels since the 1950s and the Federal Reserve boosts economic growth.
Investors buying benchmark 10-year notes will gain about 1 per cent in 2011 once interest payments are re-invested, as the yield rises to 3.65 per cent after averaging 3.2 per cent in 2010, according to a Bloomberg News survey of the Fed's 18 primary dealers. Bank of America Merrill Lynch's US Treasury Master index returned 8.15 per cent annually, since its start in 1978.
Average yields on 10-year notes are already the lowest since 1956, when Dwight D Eisenhower was president, according to “A history of interest rates” by Sidney Homer and Richard Sylla and data compiled by Bloomberg. Even though bonds declined the most in a year this month, the dealer estimates show Wall Street anticipates stable inflation as the Fed's policy of purchasing Treasuries through so-called quantitative easing stimulates growth and demand for riskier assets.
“QE2 has had unforeseen benefits in raising risk appetites and improving confidence across the board," said Mark MacQueen, a partner at Austin, Texas-based Sage Advisory Services, which oversees $9.5 billion. “At best it's going to be a mediocre year, but not negative" for Treasuries, he said.
Heartbreak hotel
Treasuries have returned 5.28 per cent this year even after December's 2.39 per cent drop, according to Bank of America Merrill Lynch data. That compares with a loss of 3.72 per cent last year and a gain of 14 per cent in 2008, when investors worldwide sought US government debt as a refuge during the financial crisis.
Ten-year note yields rose four basis points, or 0.04 percentage point, to 3.43 per cent, as of 12:23 pm in London. The price of the 2.625 per cent security maturing in November 2020 fell 10/32, or $3.125 per $1,000 face amount, to 93 10/32.
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The average 10-year yield was the lowest this year since Elvis Presley first entered the music charts with "Heartbreak Hotel" and Eisenhower defeated Adlai Stevenson for a second term. Rates reached a 2010 high of 4 per cent on April 5 and dropped as low as 2.33 per cent on October 8.
The average 3.07 per cent rate in 1956 accompanied economic growth of 1.8 per cent, consumer price gains of 3 per cent and an unemployment rate that fell to 4.1 per cent. In 2010's third quarter, the US expanded at a 2.6 percent pace, the Commerce Department said December 22. Inflation rose at a 1.1 per cent annual rate in November, while unemployment climbed to 9.8 per cent.
Economic outlook
US growth will slow to 2.6 per cent next year from 2.8 per cent in 2010, according to the median estimate of 69 economists in a Bloomberg News survey. The consumer price index is forecast to rise 1.5 per cent, a separate survey showed.
Europe's sovereign debt crisis and prospects for subdued inflation make Treasuries attractive, according to Gary Pollack, who helps oversee $12 billion as head of bond trading at Deutsche Bank AG's private wealth management unit in New York. Portugal was cut to A+ from AA- on December 23 by Fitch Ratings, which cited a slow reduction in the nation's current account deficit and a difficult financing environment.
“The Fed is buying through June and the outlook for inflation is rather benign,” said Pollack, who is purchasing Treasuries maturing in four to six years. “There are still question marks about the economy, which will keep growth below trend and support lower yields.”
Debt auctions
Demand at Treasury auctions has held near record levels even as bonds fall and the administration of President Barack Obama predicts the fiscal 2011 budget deficit will top $1 trillion for a third consecutive year.
Investors bid about $2.96 for each dollar of Treasuries sold last month, near the $3.19 peak in September and the $2.99 average through November, Treasury data show. The so-called bid- to-cover ratio was 2.5 in US note and bond sales last year.