Treasuries Market Reflects America's Fiscal Health

Investors are buying a larger share of U.S. Treasuries sold at government auctions than ever before.

America’s improving fiscal health is starting to be reflected in the market for Treasuries.

As the Federal Reserve scales back its unprecedented bond buying this year, the ability of the world’s largest debtor nation to attract investors underscores the strides the U.S. has made to strengthen its creditworthiness after the worst financial crisis since the Great Depression. With the budget deficit at a seven-year low and household wealth rising to a record, investors from mutual funds to foreign central banks are buying a greater share of Treasuries at government auctions than ever before, as bond dealers that are obligated to bid by a smaller share.

“This goes a long way to blunting the criticism of investing in the U.S. dollar,” Wan-Chong Kung, a bond manager at Nuveen Asset Management, which oversees more than $100 billion, said in an April 2 phone interview from Minneapolis.

Investors submitted bids for $1.73 trillion of government notes and bonds at auctions held in the first quarter, or 3.07 times the $564 billion that was sold, according to data compiled by Bloomberg. The bid-to-cover ratio rebounded from last year’s 2.87, which was the lowest annual level in four years.040814_Bloomberg

The last time the ratio was higher on a quarterly basis was in 2012, when demand peaked at a record 3.12 times. Investors also bought 58.7 percent of Treasury debt issued last quarter, with the rest purchased by the 22 primary dealers that trade with the Fed.

Increased demand has helped curb U.S. borrowing costs, confounding forecasters who said yields would rise as the Fed started to cut back on its $85 billion of monthly purchases of Treasuries and mortgage-backed bonds to support the economy.

After yields on the 10-year note reached a 29-month high of 3.05 percent at the start of the year, they have since declined and ended at 2.73 percent last week. Yields were little changed at 2.72 percent as of 8:40 a.m. in New York.

Economists have responded by cutting their yield estimates every month this year. They now say yields on 10-year Treasuries, a benchmark for everything from mortgages to car loans and corporate bonds, will end the year at 3.34 percent, based on last month’s median estimate in a Bloomberg survey. In January, their forecast was 3.44 percent.

Bond buyers are demanding less compensation as the U.S. fiscal balance improves. After budget shortfalls topped $1 trillion in the four years after 2008 as the government boosted spending to bail out the nation’s banks and revive the economy, the deficit is now projected to narrow to $514 billion this fiscal year, the Congressional Budget Office said on Feb. 4.

That’s equal to 3 percent of the gross domestic product (GDP), which is close to the average of the past four decades.

 

Better Shape

The gap reached 9.8 percent of GDP in 2009, the widest in at least three decades, data compiled by the agency show. A smaller deficit reduces the amount of new bonds the Treasury needs to sell, which may help buoy demand as the Fed pulls back.

The Fed, which bought more than a half-trillion dollars of Treasuries last year as part of its third round of quantitative easing, will stop purchasing bonds by October, economists’ estimates compiled by Bloomberg show.

“The borrowing is coming down sharply on the public sector side,” Robin Marshall, a fixed-income director at Smith & Williamson Investment Management, which oversees $23 billion, said in an April 2 telephone interview from London. That’s “bullish” for U.S. government bonds, he said.

Marshall said he has been buying longer-term Treasuries.

American consumers are also in better financial shape than ever before. Net worth for households and non-profit groups climbed to a record $80.7 trillion at the end of 2013, according to Fed data released last month.

After U.S. households had more of their wealth destroyed during the credit crisis than at any time since the end of World War II, they now have almost $12 trillion more in assets than their pre-recession peak in 2007.

The same goes for American companies, which amassed more than $2 trillion in cash for the first time as profits doubled from the last quarter of 2008, according to data compiled by Bloomberg and the Bureau of Economic Analysis.

Bond raters have taken notice. Fitch Ratings increased its outlook on the U.S.’s AAA grade on March 21 to stable from negative, joining Moody’s Investors Service and even Standard & Poor’s in assigning stable outlooks on the U.S. S&P dropped its rating to AA+ in August 2011, citing political wrangling over the debt limit and the lack of a plan to reduce deficits.

With the U.S. economy showing signs that the worst recession in seven decades is behind it, Richard Schlanger, a money manager at Pioneer Investments, which manages $20 billion in fixed-income securities, says there is more value in higher-yielding assets such as stocks than Treasuries.

 

More Accommodative

Growth in the world’s largest economy will accelerate to 2.7 percent this year from 1.9 percent last year, according to economists surveyed by Bloomberg. By 2015, the U.S. will expand 3 percent, which would be the fastest in a decade.

“It’s slow and steady improvement,” Schlanger said in an April 4 telephone interview from Boston. In the quarters ahead, “we’re going to see much stronger growth and then bond yields are going to drift higher.”

Exchange-traded funds that invest in U.S. stocks amassed $17.4 billion last month, the most among all classes of ETFs, data compiled by Bloomberg show. At the same time, investors yanked $10.3 billion from the funds that buy U.S. government debt, the biggest exodus since 2010.

While Fed Chair Janet Yellen accelerated the shift after saying on March 19 that a strengthening U.S. economy may prompt the central bank to lift rates six months after it stops buying bonds, last week’s payrolls report caused Treasuries to rally as speculation, that the Fed will accelerate the unwinding of its accommodation and raise its benchmark rate, cooled.

Employers added 192,000 jobs in March, less than the median forecast for a 200,000 gain in a Bloomberg survey. The result came after a 197,000 increase in February that was more than first estimated.

Last week, Yellen followed up her March comments by highlighting inconsistencies in labor-market data, saying the recovery “still feels like a recession to many Americans.”

Traders have now dialed back their wagers on the likelihood the Fed will start raising rates in June 2015 to 54 percent, based on futures trading on the CME Group Inc.’s exchange, from 64 percent a month ago. The Fed has held its benchmark rate at close to zero since 2008.

The latest data will “help keep a bid in Treasuries,” Guy Haselmann, a New York-based interest-rate strategist at primary dealer Bank of Nova Scotia, said by phone on April 4.

 

Relative Value

With inflation still below the Fed’s target of 2 percent, Haselmann said he prefers longer-dated Treasuries. U.S. government debt due 10 years or more returned 6.9 percent in the first quarter, the most since 2012. That outstripped the 1.8 percent gain including reinvested dividends for the S&P 500, the benchmark gauge for American equity.

Geopolitical strife from Russia to Thailand, as well as increasing concern over a slowdown in China, has reinforced the value of dollar-based assets. The dollar is forecast to rise 6.4 percent versus the yen and 5.4 percent against the euro by year-end, data compiled by Bloomberg show.

At the same time, yields on Treasuries are still higher relative to bonds from other major global economies, making them attractive to investors on a relative basis. The extra yield that investors get for holding 10-year U.S. notes instead of similar-maturity German bunds increased to 1.19 percentage points last week, the most since October 2005.

“It’s clear that U.S. Treasuries internationally demonstrated their place not only as the most liquid market but also, from a relative value standpoint, as very compelling,” James Camp, a money manager who oversees $5.5 billion in fixed income with Eagle Asset Management, said in a telephone interview on April 4 from St. Petersburg, Florida.

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