For the first time since the 1990s the US 30-year Treasury bond is becoming the benchmark for the world’s biggest debt investors.
The Federal Reserve’s plan to buy $600 billion of US government debt will focus about 86 per cent of its purchases in notes due in 2.5 years to 10 years, leaving the so-called long bond as the security that most closely reflects market expectations for inflation. Since the Fed’s November 3 announcement, the 30-year yield rose 0.28 percentage point, suggesting growing investor confidence in the central bank’s efforts to avoid deflation as the economy expands.
“The 30-year, with minimal Fed involvement, will become the bellwether issue for the bond market’s outlook on the economy and inflation,” 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.
Trading in Treasuries due in 11 years and more tripled since July, compared with a 60 per cent jump for all maturities, according to Fed data. Volume reached $65.7 billion in the week ended November 10 among the 18 primary dealers that trade with the central bank, the largest amount since at least 2001.
The rise in 30-year yields to a six-month high of 4.42 per cent on November 15 shows traders expect Fed Chairman Ben S Bernanke will head off deflation, which can stall recoveries by curtailing spending and investment, said Rohit Garg, an interest-rate strategist in New York at BNP Paribas SA.
The yield fell 7 basis points to 4.21 per cent last week as the price of the 4.25 per cent security due November 2040 rose 1 6/32, or $11.88 per $1,000 face value to 100 21/32, according to BGCantor Market Data.
The yield gained two basis points on Monday, rising to 4.23 per cent as of 9:52 am in London.
“The sector of the market where the Fed’s not buying will give you a truer indication of private-sector sentiment about the outlook,” Paul McCulley, a partner at Newport Beach, California-based Pacific Investment Management Co, said in a November 15 interview on Bloomberg Radio’s “The Hays Advantage” with Kathleen Hays. Pimco manages the $255.9 billion Total Return Fund, the world’s largest bond mutual fund. “We are in a sustained recovery pattern,” he said.
Government reports last week showed the US economy continuing to improve from the worst recession since the Great Depression in the 1930s.
The Commerce Department said gross domestic product expanded 2.5 per cent on an annualized basis in the third quarter, up from its initial estimate of 2 per cent. Wages and salaries jumped by $97.4 billion at an annual pace in the second quarter from the first, up from a previously reported $51.1 billion. Americans filed the fewest unemployment claims in more than two years in the week ended November 20.
Bank of America Merrill Lynch index data show 30-year bonds returned 23.6 per cent, including reinvested interest, through August, when investors began to focus on Bernanke’s August 27 statements at the central bank’s annual symposium in Jackson Hole, Wyoming. “Additional purchases of longer-term securities, should the FOMC choose to undertake them, would be effective in further easing financial conditions,” he said. The long bond lost 11.7 per cent since then.
During the speech, Bernanke laid the groundwork for the second round of bond purchases in so-called quantitative easing to add cash to the financial system and keep borrowing costs low to sustain the recovery.
The gap between yields on 10- and 30-year Treasuries reached a record 1.6 percentage points on November 10 from 1.07 on September 1. The difference typically widens when investors anticipate growth and inflation, which erodes the value of fixed payments the most for bonds due in 30 years. The interest rate on the longest-maturity debt has risen 0.75 percentage points from a 17-month low of 3.46 per cent August 25.
“The market is affirming the Fed’s actions will be successful,” said John Fath, former head Treasury trader at UBS AG and now a managing partner in New York at BTG Pactual, a Brazilian investment bank and asset manager.
Inflation expectations remain muted, as the long bond’s yield remains more than 3 percentage points below its average since 1980 of 7.40 per cent. Treasury Inflation Protected Securities, or TIPS, have returned 1.14 per cent since August, compared with a 1.49 per cent loss for Treasuries, according to Bank of America Merrill Lynch indexes.
Fed officials lowered their forecasts for economic growth at their November 2-3 meeting, projecting an expansion of 3 per cent to 3.6 per cent next year, down from 3.5 per cent to 4.2 per cent estimated in June, according to the minutes released November 23. The 2012 forecasts of 3.6 per cent to 4.5 per cent growth compare with the earlier projections of 3.5 per cent to 4.5 per cent.
“Monetary policy is totally ineffective,” said Lacy Hunt, executive vice president at Austin, Texas-based Hoisington Investment Management Co, whose Wasatch-Hoisington US Treasury Fund is buying bonds and zero-coupon securities. “The problem with the economy is excessive indebtedness. There’s lack of balance sheet capacity of the banks to make loans and there’s lack of balance sheet capacity for the borrowers to take on additional debt. Ultimately we’re going to deflation.”
The long bond served as a benchmark for governments and companies selling long-term debt since the Treasury began regular sales in 1977 until 2001, when then-Undersecretary for Domestic Finance Peter Fisher suspended auctions, saying they were too costly. Investors turned to the 10-year note as the market benchmark.
Expanding budget deficits led Treasury officials to resume sales in 2006. Offerings increased as the financial crisis worsened and tax receipts plummeted, causing the shortfall to reach $1.4 trillion in 2009. The next auction is scheduled for December 9.
Returns on the securities have historically been the most volatile in the Treasuries market. They gained 41.2 per cent in 2008 as investors seeking the safest, most liquid bonds following the collapse of Bear Stearns Cos and Lehman Brothers Holdings Inc. drove yields down to 2.51 per cent from 4.45 per cent at the start of the year.
They lost 26 per cent in 2009 as Congress passed the Obama administration’s $862 billion stimulus plan and the economy grew in the last half of the year after shrinking in four consecutive quarters, Bank of America Merrill Lynch indexes show. Yields rose to 4.64 per cent from 2.68 per cent.
“If you want to play out there you’d better have a very tight seat belt and a strong stomach,” Pollack of Deutsche Bank said in a telephone interview.
While the Fed can measure expectations for economic growth from stocks, bond yields offer the best read on whether the US will escape deflation, according to Stephen Stanley, a former RBS Securities chief economist and Richmond Fed researcher who’s chief economist at Pierpont Securities LLC in Stamford, Connecticut.
“If you’re judging between very broad economic scenarios like a Japanese-style malaise versus a normal cyclical recovery,” the 30-year bonds give better insight, Stanley said in a telephone interview November 19. “The economy is still in the early stages of improving after a soft patch in the beginning of the year.”
Stanley says the long bond’s yield will reach 5.3 per cent by the end of 2011. Investors buying the security at the current yield of 4.21 per cent would lose about 11 per cent if Stanley’s forecast is accurate, according to data compiled by Bloomberg.
As the Fed boosts inflation expectations and stimulates growth, the rise will be gradual in part because Treasuries provide a haven when investors flee riskier assets, said Richard Schlanger, who helps invest $18 billion as vice president at Pioneer Investments in Boston. Demand from pension funds and insurance companies for debt that corresponds with future liabilities, will keep the ceiling on the yield at about 5 per cent next year, he said in a phone interview.
“When you have a watershed event like we have, it lasts for a longer period of time than most people think,” he said.
