Bond Vigilantes Confront Obama as Housing Falters http://www.bloomberg.com/apps/news?pid=20601087&sid=akW9GQw.X9KM&refer=worldwide Bond Vigilantes Confront Obama as Housing Falters (Update2) By Liz Capo McCormick and Daniel Kruger May 29 (Bloomberg) -- Theyâre back. For the first time since another Democrat occupied the White House, investors from Beijing to Zurich are challenging a presidentâs attempts to revive the economy with record deficit spending. Fifteen years after forcing Bill Clinton to abandon his own stimulus plans, the so-called bond vigilantes are punishing Barack Obama for quadrupling the budget shortfall to $1.85 trillion. By driving up yields on U.S. debt, they are also threatening to derail Federal Reserve Chairman Ben S. Bernankeâs efforts to cut borrowing costs for businesses and consumers. The 1.5-percentage-point rise in 10-year Treasury yields this year pushed interest rates on 30-year fixed mortgages to above 5 percent for the first time since before Bernanke announced on March 18 that the central bank would start printing money to buy financial assets. Treasuries have lost 5.1 percent in their worst annual start since Merrill Lynch & Co. began its Treasury Master Index in 1977. âThe bond-market vigilantes are up in arms over the outlook for the federal deficit,â said Edward Yardeni, who coined the term in 1984 to describe investors who protest monetary or fiscal policies they consider inflationary by selling bonds. He now heads Yardeni Research Inc. in Great Neck, New York. âTen trillion dollars over the next 10 years is just an indication that Washington is really out of control and that there is no fiscal discipline whatsoever.â Investor Dread What bond investors dread is accelerating inflation after the government and Fed agreed to lend, spend or commit $12.8 trillion to thaw frozen credit markets and snap the longest U.S. economic slump since the 1930s. The central bank also pledged to buy as much as $300 billion of Treasuries and $1.25 trillion of bonds backed by home loans. For the moment, at least, inflation isnât a cause for concern. During the past 12 months, consumer prices fell 0.7 percent, the biggest decline since 1955. Excluding food and energy, prices climbed 1.9 percent from April 2008, according to the Labor Department. Bill Gross, the co-chief investment officer of Newport Beach, California-based Pacific Investment Management Co. and manager of the worldâs largest bond fund, said all the cash flooding into the economy means inflation may accelerate to 3 percent to 4 percent in three years. The Fedâs preferred range is 1.7 percent to 2 percent. âThereâs becoming an embedded inflationary premium in the bond market that wasnât there six months ago,â Gross said yesterday in an interview at a conference in Chicago. Shrinking Economy Bonds usually rally when the economy is in recession and inflation is subdued. Gross domestic product dropped at a 5.7 percent annual pace in the first quarter, after contracting at a 6.3 percent rate in the last three months of 2008, according to the Commerce Department. This time itâs different because the Congressional Budget Office projects Obamaâs spending plan will expand the deficit this year to about four times the previous record, and cause a $1.38 trillion shortfall in fiscal 2010. The U.S. will need to raise $3.25 trillion this year to finance its objectives, up from less than $1 trillion in 2008, according to Goldman Sachs Group Inc., one of 16 primary dealers of U.S. government securities that are obligated to bid at Treasury auctions. âThe deficit and funding the deficit has become front and center,â said Jim Bianco, president of Bianco Research LLC in Chicago. âThe Fed is going to have to walk a fine line here and has to continue with a policy of printing money to buy Treasuries while at the same time convince the market that this isnât going to end in tears with fits of inflation.â âPotential Benefitsâ Ten-year note yields, which help determine rates on everything from mortgages to corporate bonds, rose as much as 1.71 percentage points from a record low of 2.035 percent on Dec. 18. That was two days after the Fed said it was âevaluating the potential benefits of purchasing longer-term Treasury securitiesâ as a way to keep consumer borrowing costs from rising. The yield on the 10-year note climbed 14 basis points, or 0.14 percentage point, to 3.60 percent this week, according to BGCantor Market Data. The price of the 3.125 percent security maturing in May 2019 tumbled 1 5/32, or $11.56 per $1,000 face amount, to 96 2/32. The yield touched 3.748 percent yesterday, the highest since November. The dollar has also begun to weaken against the majority of the worldâs most actively traded currencies on concern about the value of U.S. assets. The dollar touched $1.4135 per euro today, the weakest level this year. Bond Intimidation Ten-year yields climbed from 5.2 percent in October 1993, about a year after Clinton was elected, to just over 8 percent in November 1994. Clinton then adopted policies to reduce the deficit, resulting in sustained economic growth that generated surpluses from his last four budgets and helped push the 10-year yield down to about 4 percent by November 1998. Clinton political adviser James Carville said at the time that âI used to think that if there was reincarnation, I wanted to come back as the president or the pope or as a .400 baseball hitter. But now I would like to come back as the bond market. You can intimidate everybody.â The surpluses of the Clinton administration turned into record deficits as George W. Bush ramped up spending, including financing of the wars in Iraq and Afghanistan. The bond vigilantes are being led by international investors, who own about 51 percent of the $6.36 trillion in marketable Treasuries outstanding, up from 35 percent in 2000, according to data compiled by the Treasury. New Group âThe vigilante group is different this time around,â said Mark MacQueen, a partner and money manager at Austin, Texas- based Sage Advisory Services Ltd., which oversees $7.5 billion. âItâs major foreign creditors. This whole idea that we need to spend our way out of our problems is being questioned.â MacQueen, who started in the bond business in 1981 at Merrill Lynch, has been selling Treasuries and moving into corporate and inflation-protected debt for the last few months. Chinese Premier Wen Jiabao said in March that China was âworriedâ about its $767.9 billion investment and was looking for government assurances that the value of its holdings would be protected. The nation bought $5.6 billion in bills and sold $964 million in U.S. notes and bonds in February, according to Treasury data released April 15. It was the first time since November that China purchased more securities due in a year or less than longer-maturity debt. Obamaâs Confidence Treasury Secretary Timothy Geithner, who will travel to Beijing next week, will encourage China to boost domestic demand and maintain flexible markets, a Treasury spokesman said yesterday. Obama spokesman Robert Gibbs said the president is confident that his budget and economic plans will cut the deficit and bring down the nationâs debt. âThe president feels very comfortable with the steps that the administration is taking to get our fiscal house in order and understands how important it is for our long-term growth,â Gibbs said. Investors are also selling Treasuries as the economy shows signs of bottoming and credit and stock markets rebound, lessening the need for the relative safety of government debt. And while yields are rising, they are still below the average of 6.49 percent over the past 25 years. -CONTINUED-
-CONTINUED- âRenewed Appreciationâ The worldâs largest economy will begin to expand next quarter, according to 74 percent of economists in a National Association for Business Economics survey released this week. The Standard & Poorâs 500 has risen 34 percent since bottoming on March 9, while the London interbank offered rate, or Libor, that banks say they charge each other for three-month loans, fell to 0.66 percent today from 4.819 percent in October, according to the British Bankersâ Association. Three-month Treasury bill rates have climbed to 0.13 percent after falling to minus 0.04 percent Dec. 4. That flight to safety helped U.S. debt rally 14 percent in 2008, the best year since gaining 18.5 percent in 1995, Merrill indexes show. âYes thereâs been a big move, and you can argue the big move is driven by the renewed appreciation of the risks associated with holding long-term Treasury bonds,â said Brad Setser, a fellow for geoeconomics at the Council on Foreign Relations in New York. Fed officials see several possible explanations for the rise in yields beyond investor concern about inflation. Among them: The supply of Treasuries for sale exceeds the Fedâs $300 billion purchase program, the economic outlook is improving and investors are selling government debt used as a hedge against mortgage securities. Liquidity Central bankers want to avoid appearing to react solely to market swings. Bernanke hasnât formally asked policy makers to consider whether to increase Treasury purchases and may not do so before the Federal Open Market Committeeâs next scheduled meeting June 23-24. Officials are confident they can mop up liquidity without gaining additional tools from Congress, such as the ability for the Fed to issue its own debt. The Fed declined to comment for the story. Bernanke has an opportunity to discuss his views when he testifies June 3 before the House Budget Committee in Washington. âWe have daily reminders from bond vigilantes like Bill Gross about the prospect of losing our AAA rating,â Federal Reserve Bank of Dallas President Richard Fisher said in Washington yesterday. âThis cannot be allowed to happen.â Repair the Damage The government and Fed are trying to repair the damage from the collapse of the subprime mortgage market in 2007, which caused credit markets to freeze, led to the collapse of Lehman Brothers Holdings Inc. in September and was responsible for $1.47 trillion of writedowns and losses at the worldâs largest financial institutions, according to data compiled by Bloomberg. The initial progress Bernanke made toward reducing the relative cost of credit is in jeopardy of being unwound by the work of the bond vigilantes. The average rate on a typical 30-year fixed mortgage rose to 5.08 percent this week from 4.85 percent in April, according to North Palm Beach, Florida-based Bankrate.com. Credit card rates average 10.5 percentage points more than 1-month Libor, up from 7.19 percentage points in October. âLonger term the danger is that the rise in yields disrupts the recovery or the rise in inflation expectations dislodges the Fedâs current complacency on inflation,â Credit Suisse Group AG interest-rate strategists Dominic Konstam, Carl Lantz and Michael Chang wrote in a May 22 report. âItâs Overâ Inflation expectations may best be reflected in the yield curve, or the difference between short- and long-term Treasury rates. The gap widened this week to 2.76 percentage points, surpassing the previous record of 2.74 percentage points set on Aug. 13, 2003. Investors typically demand higher yields on longer-maturity debt when inflation, which erodes the value of fixed-income payments, accelerates. âThe yield spreads opening up imply that inflation premiums are rising,â said former Fed Chairman Alan Greenspan in a telephone interview from Washington on May 22. âIf we try to do too much, too soon, we will end up with higher real long- term interest rates which will thwart the economic recovery.â Other economists are more pointed. After falling from 16 percent in the early 1980s, 10-year yields have nowhere to go but up, according to Richard Hoey, the New York-based chief economist at Bank of New York Mellon Corp. âThe secular bull market in Treasury bonds is over,â Hoey said in a Bloomberg Television interview. âIt ran a good 28 years. Theyâre never going lower. Thatâs it. Itâs over.â