Signs of wear and tear for Treasuries
The article from the Financial Times below is talking to some of the issues I outlined in my last 2 posts. It sounds like Treasuries are starting to show signs of wear and tear.
Treasuries caught in the crossfire of ‘two realities’
By Michael Mackenzie
Published: February 26 2009 02:00 | Last updated: February 26 2009 02:00
US bond investors are caught between two competing forces. Pulling one way is an economy that is still deteriorating amid a falling housing market, hefty job losses and low consumer confidence. Pulling the other way are record new debt sales - needed to finance the country’s bank rescue and fiscal stimulus packages.
The stalemate between these two forces helps to explain why Treasury yields remain anchored in a well-defined range, unable to make a decisive break higher, or return to their recent historic lows.
This week, this dynamic has been aptly illustrated: the US Treasury has embarked on selling $94bn in new two-, five- and seven-year notes just as the S&P 500 has dropped to its lowest level since 1997 amid a new raft of dire economic data, notably for housing.
Late yesterday, the yield on the benchmark 10-year note was at 2.95 per cent, up from below 2.80 per cent on Monday.
“The economy continues to worsen, keeping rates from rising unduly, as the tsunami of Treasury issuance constrains the market’s ability to rally a lot,” says David Ader, strategist at RBS Greenwich Capital. “Effectively, rates seem bookended by these two realities.”
In general, bond dealers expect the two-year note to trade between 0.75 per cent and 1.1 per cent, a ceiling which held yesterday, while the 10-year note trades between 2.60 per cent and 3 per cent.
At the start of the year, the 10-year was yielding just above 2 per cent and early in February it briefly went above 3 per cent, amid concerns about supply and whether foreign investors would keep buying Treasuries.
Yesterday, the second leg of this week’s Treasury debt sales sparked solid demand for a record $32bn in five-year notes. That came after $40bn in two-year notes was sold on Tuesday and attracted reasonable demand.
Today the seven-year note returns for the first time since being suspended in 1993. The $22bn offering is also a record amount for this issue as the Treasury remains on course to sell some $2,200bn in new debt for the current financial year.
This month, the Treasury sold $67bn in three-, 10- and 30-year debt. In effect, bond dealers and investors are now facing two hefty slugs of issuance each month.
For now, the lack of any positive signs for the economy is keeping a lid on bond yields as worries over supply are neutered.
Economists increasingly believe an anaemic recovery will only emerge next year, whereas a few months ago, there was hope of a rebound in the second half of this year.
“Given the economic news, I don’t see a better investment opportunity than Treasuries over the next six to nine months,” says Tom di Galoma, head of treasury trading at Jefferies & Co.
The prospect of a further fall in equities, as the economy struggles to find a footing, means Treasuries will attract buyers and cap yields, argue dealers.
“People have been worried about supply but those fears ease when stocks show no sign of a bottom,” says Rick Klingman, managing director at BNP Paribas.
“Until stocks steady, parking your money in a 1 per cent two-year note doesn’t sound too bad. At the moment, preservation of capital is the priority.”
Once the latest Treasury debt sales are completed, attention will focus on data due in the first week of March, crowned by the monthly employment report for February.
John Ryding, chief economist at RDQ Economics, says the economy remains in deep trouble and that job losses for February could reach 700,000. Meanwhile, the tone of recent data suggests a first-quarter contraction in activity of some 5 per cent, he adds.
That said, there are signs that supply is weighing on the bond market and could become a much heavier burden in the coming months.
Mr Ader highlights this week’s moves in Treasury prices and yields against a backdrop of bad economic news and fears over the financial sector.
“If yields can’t fall further on the steady litany of bad economic news and disconcerting stocks, the bond market has a problem,” warns Mr Ader.
At some point, the sheer scale of debt issuance is expected to weigh on the appetite of Treasury investors.
There is also a fear that foreign investors, facing bleak domestic economic prospects, could sell their current Treasury holdings.
Mr Ryding expects the yield on the 10-year note to rise to 4 per cent by the end of the year. “The problem for the US is that more than 50 per cent of our debt is held by foreign investors.”
Ultimately, Mr Klingman says the long-term trade looks bearish for Treasuries and investors who stay in the market are staring at losses.
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