The U.S. 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 U.S. drew an all-time high bid-to- cover ratio of $9.07 for $30 billion of four-week bills it auctioned on Dec. 20 even though they pay zero percent interest.
While Standard & Poor’s stripped the U.S. of its AAA credit rating on Aug. 5, Treasuries due in 10 years or more returned 25.6 percent this year. The spreading sovereign debt crisis in Europe and slower global growth are driving investors to the safety of U.S. 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 Dec. 21 telephone interview. “We have a significantly shrinking supply of risk-free assets in the world and U.S. 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 percent.
Treasuries were some of the best assets to own this year, returning 8.9 percent, compared with a decline of 8 percent for the Thomson Reuters/Jefferies CRB Index of raw materials and a 0.6 percent gain in the Standard & Poor’s 500 Index of stocks. Global sovereign debt and mortgage-backed securities rose 5.8 percent, and corporate bonds climbed 4.3 percent, according to Bank of America Merrill Lynch bond indexes.
The dollar is poised to strengthen for a second straight year against its major trading partners, appreciating 1.2 percent as measured by IntercontinentalExchange Inc.’s Dollar Index. The gauge rose 1.5 percent gain in 2010.
“The U.S. 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 Dec. 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 percent, they are down from 3.3 percent at the end of 2010, Bloomberg Bond Trader prices show. The rates fell one basis point to 2.01 percent at 11:58 a.m. in Tokyo, and the 2 percent security due November 2021 added 1/8, or $1.25 cents per $1,000 face amount, to 99 29/32.
Low yields mean that interest expense accounted for 3 percent of the economy in fiscal 2011 ended Sept. 30, down from 4 percent in 1999. When the U.S. 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 Dec. 21 telephone interview. “Most people thought if the U.S. 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 percent 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 Dec. 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 percent. FTN Financial had the lowest estimate, at 2 percent. For the end of 2012, the median forecast is 2.6 percent.
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 percent.
They were at 6.57 percent in January 1993 at the end of the elder Bush’s presidency, down from 9.54 percent in early 1989 when he took office as the Fed cut its target rate for overnight loans between banks to 3 percent from a high of 9.75 percent in February 1989 as growth slowed. Yields have averaged 4.92 percent 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.
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 U.S. government borrowing surpassed $15 trillion. The yen is the only major currency to have outperformed the dollar, rising 4.1 percent.
“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 Dec. 16 telephone interview. “You have more people chasing fewer risk-free assets. Everything points right now in the same direction.”
U.S. government debt will post its best five-year performance, gaining 39 percent from the start of 2007, since they returned 45 percent from 1998 through 2002, a period that included the failure of Long-Term Capital Management LP, the collapse in internet stocks and the Sept. 11 terror attacks.
That’s even as budget deficits have totaled $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 Nov. 2 meeting.
About 45 percent 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 Dec. 21 telephone interview.
The economy will likely expand 2.1 percent in 2012 and 2.5 percent in 2013, according to median forecasts in a Bloomberg News survey. The Fed’s forecast is for 2.7 percent growth in 2012 and 3.25 percent in 2013.
In addition to keeping its benchmark rate at a record low, policy makers moved on Sept. 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 Dec. 16 telephone interview. “They’re not going to settle for trend growth. They want more.”
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