Record Demand For Treasuries As Pessimism Over Economic Recovery Grows

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  1. Record demand for treasuries.

    Treasuries Record Demand Damps Concern Supply to Grow (Update1)
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    By Dakin Campbell and Daniel Kruger

    July 13 (Bloomberg) --
    Bond investors across the country are snapping up 10-year Treasury notes as expectations for a U.S. economic recovery this year disappear.

    Firms from New York-based BlackRock Inc. to Franklin Templeton Investments in San Mateo, California, are turning more bullish a month after yields on Treasuries rose to the highest since October. Declining consumer confidence, falling stocks and unemployment climbing toward 10 percent has overcome concern that record auctions of government debt will overwhelm demand. Barclays Plc estimates $1.1 trillion more sales by the end of the year, on top of the first half’s $963 billion.

    The gap between yields on 10-year Treasury notes and two- year securities narrowed to 2.40 percentage points from a record 2.81 percentage points on June 5 as investors took advantage of relatively cheap longer-term debt. The so-called yield curve typically widens when investors anticipate a recovery because they demand more compensation for the risk that growth will spark inflation.

    “You are starting to hear more concerns about how well the economy is doing,” said Michael Materasso, co-chairman of the fixed-income policy committee at Franklin Templeton, which oversees $128 billion in bonds.

    Franklin reduced its holdings of corporate bonds that perform better than government debt in an expanding economy and added Treasuries due in about 10 years in the past two weeks, Materasso said.


    The yield on the benchmark 10-year note fell 20 basis points, or 0.2 percentage point, last week to 3.30 percent in New York, according to BGCantor Market Data, as an auction of $19 billion of the securities drew the most demand ever. The 3.125 percent note due May 2019 rose 1 20/32, or $16.25 per $1,000 face amount, to 98 16/32. The yield was little changed today as of 12:19 p.m. in Tokyo.

    The bid-to-cover ratio, which gauges demand by comparing total bids with the amount of securities offered, was 3.28 on July 8, up from 2.62 at the last auction of the notes on June 10 and above the average of 2.38 at the previous 10 sales.

    Stock markets also show growing concern about a recovery. The Standard & Poor’s 500 Index fell in each of the past four weeks, declining 7 percent to 879.13.

    Materasso, who is based in New York, expects the yield curve to narrow to 2 percentage points. An investor buying $100 million of 10-year notes betting on a so-called flattening will earn $4.89 million if the gap narrows to 2 percentage points, according to data compiled by Bloomberg. That assumes that the two-year note yield remains constant at 0.90 percent.

    Curve Forecast

    Based on the median of at least 55 estimates in Bloomberg surveys of two- and 10-year yields, the curve will shrink to 2.35 percentage points by 2010. A month ago, the median was 2.48 percentage points, while in May it was 2.15 percentage points.

    Before this year, the curve peaked at 2.74 percentage points in August 2003, as economic growth surged to 7.5 percent that quarter.

    So far in July, 10-year notes have returned 2 percent, the first positive month since March, when the Federal Reserve said it would buy as much as $300 billion in Treasuries to drive down borrowing costs and spur the economy, according to a Merrill Lynch & Co. index.

    Yields on Treasuries rose last month to the highest relative to German bunds of similar maturity since 2007 and exceed the rate of inflation by the most since 1994.

    Rising Debt Sales

    Investors anticipating yields to fall from June to September, as they have in 15 of the last 20 years, may be disappointed as the Treasury accelerates debt sales to finance a budget deficit the Congressional Budget Office projects will quadruple to $1.85 trillion in the fiscal year ending Sept. 30.

    The yield curve steepened in the first half as 10-year notes lost 8.7 percent and two-year securities gained 0.12 percent amid concern U.S. debt sales would push up borrowing rates as the worst recession in 50 years came to an end. The U.S. more than doubled issuance in the first half. Sales for the rest of the year would be more than the total in all of 2008, based on the estimates by London-based Barclays, one of the 17 primary dealers required to bid at Treasury auctions.

    “Where do I find the going away demand to choke down four times the amount of supply in the marketplace than what they had to deal with last year?” said Mitchell Stapley, who oversees $22 billion as chief fixed-income officer at Grand Rapids, Michigan-based Fifth Third Asset Management. “It’s a tough one.”

    Fed Outlook

    The Fed’s announcement June 24 that it anticipates keeping the target rate for overnight loans between banks at zero to 0.25 percent for an extended period is keeping two-year notes anchored near current levels.

    Ten-year yields climbed to 4 percent on June 11 for the first time since October as investors raised concerns about President Barack Obama’s attempts to revive the economy with deficit spending. They also began to anticipate a recovery after Fed Chairman Ben S. Bernanke said in March that he saw “green shoots” in credit markets that would lead to a recovery.

    The Libor-OIS spread, which measures banks’ willingness to lend, narrowed to 31 basis points, from a record 364 basis points in October.

    Investors are piling back into Treasuries after consumer confidence declined in July following four months of gains. The government reported that the jobless rate rose in June to 9.5 percent from 9.4 percent the previous month.

    ‘Fundamental Headwinds’

    “The economy still faces pretty fundamental headwinds from the employment situation and the inflation picture,” said Stuart Spodek, co-head of U.S. bonds in New York at BlackRock, which manages $474 billion in debt.

    The S&P 500’s drop followed gains of as much as 40 percent since March. Investors are growing more concerned that prices outpaced prospects for a recovery from the longest slump in corporate profits on record.

    Investors demand 10.89 percentage points more in yield to own high-yield, or junk, bonds rather than government debt, up from this year’s low of 10.4 percentage points June 15, Merrill Lynch & Co. indexes show.

    Doubts the economy will recover this year are showing up in the currency market, where the yen appreciated to 128.95 per euro from this year’s low of 139.22 on June 5. The yen typically strengthens when investors unwind investments in higher-yielding assets financed with yen.

    ‘Classic Indicators’

    “Classic indicators of risk aversion such as euro-yen have continued to show strong hints of rising,” William O’ Donnell, head of Treasury strategy at RBS Securities Inc. in Stamford, Connecticut, wrote in a note to clients July 10. “There’s every indication that investors are questioning the strength of the green shoots rebellion hatched this spring.”

    Investors have also become more bullish on longer-maturity debt after the Fed tempered inflation expectations at its June policy meeting.

    “Substantial resource slack is likely to dampen cost pressures,” the Federal Open Market Committee said in a statement after meeting June 24. “Inflation will remain subdued for some time.”

    The gap between rates on 10-year notes and Treasury Inflation Protected Securities, or TIPS, which reflects the outlook for consumer prices, narrowed to 1.51 percentage points today, the least since May 14, from a nine-month high of 2.13 percentage points June 10.

    “As commodity prices continue to come off and TIPS breakevens continue to come off, you should see some of that risk premium taken out of 10-year yields,” said Todd White, who oversees government debt trading in Minneapolis at RiverSource Investments in Minneapolis, which manages $86 billion of bonds.

    Relative Bargain

    Treasuries are a bargain compared with European debt and inflation. Yields on 10-year notes rose last month to 28 basis points more than bunds, the highest since October 2007. As recently as December, Treasuries yielded 28 basis points less than bunds.

    The cost of living in the U.S. fell the last 12 months by the most in six decades, the Labor Department said June 17. The government will report the measure on July 15. Prices rose 0.6 percent in June, according to a Bloomberg survey of 16 economists.

    Yields on 10-year notes exceeded the consumer price index for the trailing 12 months by 5.25 percentage points, the most since November 1994, when the gap was 5.38 percentage points.

    “The trend is for no V-shaped recovery and subdued global growth and therefore no inflation,” said Michael Cheah, who manages $2 billion in bonds at SunAmerica Asset Management in Jersey City, New Jersey. “I’m betting the curve will flatten again.”

    To contact the reporters on this story: Dakin Campbell in New York at; Daniel Kruger in New York at
    Last Updated: July 12, 2009 23:26 EDT