In a world awash with U.S. government bonds, buyers of the longest-term Treasuries are facing a potential shortage of supply.
Excluding those held by the Federal Reserve, Treasuries due in 10 years or more account for just 5 percent of the $12.1 trillion market for U.S. debt. New rules designed to plug shortfalls at pension funds may now triple their purchases of longer-dated Treasuries, creating $300 billion in extra demand over the next two years that would equal almost half the $642 billion outstanding, Bank of Nova Scotia estimates.
Fewer available bonds, along with a lack of inflation and increased foreign buying, help to explain why longer-term Treasuries are surging this year even as the Fed pares its own bond purchases. The demand has pushed down yields on 30-year government debt by more than a half-percentage point to 3.37 percent, the most since 2000, data compiled by Bloomberg show.
“The long end of the Treasury market has become a bit of a commodity, and it’s driven by a scarcity and liquidity valuation,” Guy Haselmann, an interest-rate strategist at Bank of Nova Scotia, one of the 22 primary dealers that trade with the Fed, said in an April 28 telephone interview from New York. “The pressure on the long end will be for lower yields.”
Yields on the 30-year U.S. government bond were at 3.35 percent as of 7 a.m. in New York.
Lower financing costs matter because the U.S. government has more than doubled its marketable debt obligations since the financial crisis in 2008 after bailing out the nation’s banks and running deficits to kick-start an economy crippled by the worst recession since the Great Depression.
While forecasters anticipated that U.S. borrowing costs would rise for a second year as the economy strengthens enough to enable the Fed to end its debt purchases, investors instead poured into longer-term Treasuries and pushed yields lower.
Treasuries due in 30 years, the longest-maturity debt issued by the U.S., returned 12.3 percent this year, the most for that period in data compiled by Bank of America going back to 1988. The bonds gained last week, reducing yields to the lowest in more than 10 months, as signs of uneven economic growth and escalating tensions between Russia and Ukraine pushed investors into the safety of U.S. debt.
The advance for the year stands in contrast to 2013, when 30-year bonds paced longer-term Treasuries to the worst losses among government debt globally, falling 12.5 percent while U.S. equities surged 30 percent, the most since 1997.
“The long bond is marching to the tune of its own drum,” David Rosenberg, the chief economist at Gluskin Sheff & Associates in Toronto, said in a telephone interview on April 29. “There is natural institutional demand.”
One reason for the rebound is that pension plans, which oversee $16.3 trillion, are shifting into longer-term Treasuries to lock in last year’s stock gains by matching assets with their future liabilities as funding deficits narrow.
The 100 biggest U.S. corporate pensions were about 88 percent funded at the end of last year, the highest since October 2008, according to data compiled by Milliman Inc., a pension advisory firm based in Seattle.
Merck & Co.’s $17.4 billion pension was fully funded for the first time in six years as plan assets at the second-biggest U.S. drugmaker exceeded liabilities by the most since 1999, data compiled by Bloomberg show.
The $16.3 billion pension plan at Caterpillar Inc., the world’s largest maker of construction machinery, increased debt to 35 percent, the most in at least a decade, as funding levels rose to the highest since 2007, the data show.
Lainie Keller, a spokeswoman at Whitehouse Station, New Jersey-based Merck, and Rachel Potts, a spokeswoman at Peoria, Illinois-based Caterpillar, both declined to comment.
Fixed-income demand has “far outpaced the supply,” Brett Cornwell, vice president of fixed-income at Callan Associates, an adviser to pension funds with $2 trillion of assets, said by telephone from San Francisco on May 1. “We should continue to see this de-risking of corporate pension plans.”
Pensions that closed deficits are pouring into Treasuries and exiting stocks to reduce volatility after a provision in the Budget Act of 2013 raised the amount underfunded plans are required to pay in insurance premiums over the next two years. It also imposed stiffer fees on those with shortfalls.
In the next 12 months alone, buying from private pensions will create $150 billion in demand for longer-maturity Treasuries, based on Bank of Nova Scotia’s estimates.
That compares with the $40 billion in all maturities of U.S. government debt that the plans bought last year.
Stronger U.S. economic growth still means the bullishness toward Treasuries may not last, according to Gene Tannuzzo, a Minneapolis-based money manager at Columbia Management Investment Advisers, which oversees $340 billion.
Employers added more jobs in April than at any time since January 2012, a government report showed last week, and the jobless rate plunged to the lowest since the collapse of Lehman Brothers Holdings Inc. The 288,000 gain supported the Fed’s view that the world’s largest economy is perking up after harsh winter weather caused growth to stagnate last quarter.
Forecasters in a Bloomberg survey predict the economy will expand 2.7 percent this year and accelerate 3 percent next year, which would be the fastest pace since 2005.
“The economy will get better,” said Tannuzzo. “There are some technical things that have gone on that has pushed the long end down temporarily. They tend not to be sustaining trends.”
He said yields on 30-year debt should be as much as 0.75 percentage point higher than current levels, or 4.12 percent. That’s in line with the 4.14 percent year-end level using the weighted average of 49 estimates in a Bloomberg survey.
Wilmer Stith, a fund manager at Wilmington Trust Investment Managers, says long bonds will remain in demand relative to shorter-term notes as long as inflation is subdued.
The Fed’s preferred measure of inflation, the personal consumption expenditures deflator, rose 1.1 percent in March from a year ago, a report on May 1 showed. The gauge has now fallen short of the bank’s 2 percent target for two years.
The lack of wage growth may be helping contain inflation, even as the economy adds more jobs. Average hourly earnings in April failed to rise from the previous month, compared with economists' estimates for a 0.2 percent increase.
“Inflation really continues to be very well behaved and looks to be that way for quite some time,” Stith said. Wilmington Trust Investment is an affiliate of Wilmington Trust, which oversees $82 billion including pension assets.
The extra yield investors demand to hold 30-year bonds instead of five-year notes decreased last week to the least since September 2009, data compiled by Bloomberg show.
The smallest U.S. deficit in seven years is also reducing the supply of new bonds used to finance government spending.
Net issuance of interest-bearing Treasuries will fall to $545 billion next year, estimates from primary dealer Deutsche Bank AG show. That’s a 36 percent decrease from last year.
The scarcity will act as a counterbalance to the Fed as it tapers, according to Dominic Konstam, Deutsche Bank’s New York- based global head of interest-rate research.
The central bank, which bought $85 billion of Treasuries and mortgage bonds each month last year in its third round of quantitative easing, or QE, has cut those purchases by $10 billion in each of its four meetings in 2014. It said last week further decreases are likely in “measured steps.”
“The Fed stepping away at the end of QE doesn’t necessarily create a major hurdle in the Treasury market,” Konstam wrote in a report dated April 25. “We expect foreign and pension investors to take the brunt of the net Treasury supply, leaving only a small portion to other investors.”
Overseas investors own $5.9 trillion, or 48.5 percent of the market for U.S. Treasuries, more than double the amount they held in January 2008, according to the Fed.
Foreigners have increased holdings of Treasuries every year since at least 2000. China, the biggest foreign creditor to the U.S., held $1.27 trillion in Treasuries as of Feb. 28, approaching the record $1.32 trillion the country owned at the end of November. Japan, the second-largest, had $1.2 trillion of U.S. government debt, an all-time high.
Central banks are choosing to park their currency reserves in Treasuries because they offer higher returns relative to other nations, according to Jake Lowery, a manager at ING U.S. Investment Management, which oversees $200 billion.
Treasuries due in 30 years yield a full percentage point more than the 2.34 percent for German debt of the same maturity, according to data compiled by Bloomberg. The gap is now almost double the average for the past decade.
“The competition globally for places to put reserves for foreign central banks is much less attractive,” Lowery said in an April 30 telephone interview from Atlanta. “For global investors, it’s a game of relative value.”