Biggest Bond Traders See Worst Over for Treasuries

By Daniel Kruger and Cordell Eddings – Jun 18, 2012 11:21 AM GMT+0200


As the U.S. recovery slows and Federal Reserve efforts to boost growth expire, there’s no consensus among the biggest bond dealers that the central bank will begin a fourth round of economic stimulus with consumer and corporate borrowing costs already at record lows.

Signs of faltering growth amid European debt turmoil, combined with inflation below the central bank’s 2 percent target, mean the Fed will announce new steps to boost the economy as soon as a meeting this week, according to 12 of the 21 primary dealers who trade with the central bank. The remainder don’t expect action and some of the nine firms say that yields near all-time lows limit the effectiveness of more measures by policy makers.


Federal Reserve Chairman Ben S. Bernanke

Federal Reserve Chairman Ben S. Bernanke

Andrew Harrer/Bloomberg

Ben S. Bernanke, chairman of the Federal Reserve.

Ben S. Bernanke, chairman of the Federal Reserve. Photographer: Andrew Harrer/Bloomberg

The Fed kept the economy growing for nine-straight quarters by pumping $2.3 trillion into the financial system starting in November 2008 and shifting $400 billion into longer-term debt. With Freddie Mac reporting that the average 30-year mortgage interest rate has fallen to 3.71 percent and Bank of America Merrill Lynch bond indexes showing that yields on corporate bonds have fallen to 3.44 percent from more than 8 percent in early 2009, dealers say borrowing costs can’t fall much more.

“The bottom line is the Fed’s activity would have limited effect, and there is a question of how much lower does the Fed want to drive rates,” Larry Dyer, an interest rate strategist with primary dealer HSBC Holdings Plc in New York, said in a June 14 telephone interview.

Changing Views

HSBC didn’t make a forecast in a previous survey in March, when 15 firms saw more stimulus coming. Bank of America Corp., BMO Capital Markets, RBC Capital Markets and Nomura Securities International changed their views and expect no Fed action at the June 19-20 meeting. JPMorgan Chase & Co. and Barclays Plc altered their expectations in favor of more steps by the Fed.

Ben S. Bernanke, the Fed chairman, testified to Congress June 7 that further asset purchases could boost the economy, yet may bring “diminishing returns” as interest rates are already at about record lows. The 10-year note had traded as low as 1.4387 percent on June 1, down from last year’s high of 3.77 percent in February and 4.27 percent in 2008.

The average 30-year mortgage rate fell to 3.67 percent June 7 from more than 6.5 percent in 2008, according to Freddie Mac. Yields on high-quality corporate debt dropped to 3.33 percent in May, according to Bank of America Merrill Lynch bond indexes.

Lowest Coupons

Time Warner Inc. (TWX), the owner of the Warner Bros. movie studio, raised $1 billion in a two-part offering this month at its lowest coupons on record, according to data compiled by Bloomberg. The company sold $500 million of 3.4 percent 10-year notes and an equal amount of 4.9 percent 30-year bonds.

The benchmark 10-year note yield was little changed at 1.59 percent at 10:12 a.m. London time, after rising as high as seven basis points, or 0.07 percentage point, to 1.65 percent, according to Bloomberg Bond Trader data. Thirty-year yields were also little changed at 2.70 percent. They touched a record low of 2.51 percent on June 1.

“At these rate levels if you lower the 10-year yield much, does it really change the economic outlook? No,” said Michael Cloherty, head of U.S. interest rate strategist at RBC Capital Markets in New York in a June 14 telephone interview.

Demand for U.S. debt shows no signs of slowing. The government sold 10-year notes and 30-year bonds at record low yields at auctions last week as concern mounted about the risk to Spain’s sovereign debt even after agreeing to a $127 billion package from the 17-nation euro area to bail out its banking system.

Quarterly Return

Treasuries returned 3.3 percent this quarter through June 15 including reinvested interest as Spain became the fourth country in the European Union to seek a bailout and speculation rose that Greece may leave the euro, Bank of America Merrill Lynch’s Treasury Master index showed. The MSCI World Index (MXWO) of stocks lost 7.1 percent including reinvested dividends.

Investors have bid $3.19 for each dollar of the $969 billion of notes and bonds auctioned by the U.S. Treasury Department this year, above the record $3.04 in all of 2011, data compiled by Bloomberg show. Demand has soared even as the Treasury’s outstanding debt has climbed to $10.49 trillion from $4.34 trillion in June 2007.

That means the cost to President Barack Obama’s administration of financing a fourth-straight deficit exceeding $1 trillion is declining. The U.S. spent $272 billion on interest expense in fiscal 2012 through May, compared with $275.3 billion at the same point in fiscal 2011.

Fed Assets

The Fed’s balance sheet now totals $2.87 trillion, the average since June 2011 when it allowed its $600 billion second round of U.S. government debt purchases to expire, and up from $901.3 billion in August 2008, before the collapse of Lehman Brothers Holdings Inc.

Since its purchases ended in June 2011, the central bank has said it would hold borrowing costs near zero through late 2014 and bought $400 billion of longer-term U.S. government securities while selling a like amount of short-term debt. That program, known as Operation Twist, expires this month, raising speculation on whether policy makers will extend the measure.

Further action might have “diminishing impact, but if the impact’s diminishing, that doesn’t mean they shouldn’t do it,” said John Briggs, a U.S. government bond strategist at RBS Securities Inc. in Stamford, Connecticut. RBS forecasts a 60 percent likelihood of additional Fed stimulus through more buying of longer-maturity issues or additional asset purchases.

Jobs Stall

The U.S. economy, which added 1.7 million positions to the work force since July, has seen job growth stall. After boosting jobs by 757,000 from December through February, only 289,000 people joined the rolls from March through May, Labor Department data show. The unemployment rate, which has fallen to 8.2 percent from 9.1 percent in July, is unchanged from March.

Consumer prices rose 1.7 percent for the 12 months ended May, the Labor Department said June 14, below the Fed’s target of 2 percent. Bond traders forecast inflation will average 2.14 percent during the next 10 years, based on the difference in 10- year yields for Treasury Inflation-Protected Securities and conventional government debt.

The Fed might keep exchanging shorter for longer term bonds and add more mortgages to its purchases after the program ends this month, according to New York-based Ward McCarthy, chief financial economist at Jefferies & Co.

‘Modified Twist’

“A modified Twist is warranted because inflation is below their target and the unemployment rate is above it,” McCarthy said in an interview on June 12.

The U.S. will grow 2.2 percent this year, according to the median forecast by 93 economists in a Bloomberg poll published June 6, compared with a 2.3 percent projected growth rate in a survey the month before. That’s still faster than the 1.9 percent pace of the first quarter.

Primary dealers boosted their holdings of U.S. government debt to a record $136.4 billion as of June 6, according to central bank data. Of those, $102.3 billion mature in three years or less, matching the maturities the Fed is selling as part of Operation Twist.

“They already have a lot invested in the easing programs through all the various QEs, the Twist, and the low-rate communication policy,” said George Goncalves, head of interest- rate strategy at Nomura Holdings Inc. in a June 11 telephone interview. “That is already an accommodative stance for the Fed. They’d rather wait now and see what happens out of Europe.”

European Turmoil

Greece’s largest pro-bailout parties, New Democracy and Pasok, won enough seats yesterday to forge a parliamentary majority, official projections showed, easing concern the country was headed toward an imminent exit from the euro. European governments indicated a willingness to adjust the terms of Greece’s bailout package as long as a new government “swiftly” emerges from the election, according to a statement by finance chiefs in the euro area.

The yield on Spain’s benchmark 10-year notes reached a euro-era record 6.92 percent June 14 after Moody’s Investors Service cut its rating on the nation three levels to Baa3, one step above junk. Investors demanded 5.3 percentage points more to hold its 10-year debt than that of Germany, with which it shared an AAA rating as recently as September 2010.

“Unless Greece is kicked out of the euro, the Fed is going to sit on the sideline and keep their powder dry until things get worse,” said Scott Graham, head of government bond trading at Bank of Montreal’s BMO Capital Markets unit in Chicago, in a June 14 telephone interview. “The Fed doesn’t have tons of bullets left, but they can still be effective, and they know that there won’t be much good to look at even if Europe is resolved.”

Primary Dealer Forecasts for Additional Fed Monetary Easing:

Firm                March         June 20 Meeting

Bank of America       Yes            No
Barclays              No             Yes
BMO Financial         Yes            No
BNP Paribas           Yes            Yes
Cantor Fitzgerald     Yes            Yes
Citigroup             Yes            Yes
Credit Suisse         Yes            Yes
Daiwa                 No             No
Deutsche Bank         No             No
Goldman Sachs         Yes            Yes
HSBC                  N/A            No
Jefferies             Yes            Yes
JPMorgan Chase        No             Yes
Mizuho                Yes            Yes
Morgan Stanley        Yes            Yes
Nomura                Yes            No
RBC                   Yes            No
RBS                   Yes            Yes
Scotia Capital        Yes            No
Societe Generale      Yes            Yes
UBS                   No             No
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