The highest inflation-adjusted yields in the world’s most-developed bond markets are appeasing investors waiting for President Barack Obama to begin reducing the more than $1.2 trillion U.S. budget deficit.
Treasury 10-year notes pay 1.83 percent after subtracting consumer price increases, compared with 1.39 percent for German bunds and 1.1 percent for Japanese government bonds. Gilts yield 35 basis points more than the U.K.’s inflation rate.
Obama and Federal Reserve Chairman Ben S. Bernanke are benefiting from the slowest inflation, excluding food and energy costs, since before the 1960s as so-called real yields lure investors to finance the deficit and stimulate the economy. Foreign buyers, who own more than half the $8.86 trillion in outstanding U.S. marketable debt, have added to their holdings of Treasuries for 18 consecutive months through October.
“There has been grumbling about the deficit, but the market is betting that policy makers will do the right thing and focus on growth, which will help the debt picture in the long run,” Jack McIntyre, a fund manager who oversees $21 billion in debt at Brandywine Global Investment Management in Philadelphia, said. “Real yields are at levels that make them attractive with the lack of inflation pressure the market is seeing, a still weak recovery and a stubborn lack of job growth.”
Bond Rally
Real yields in the U.S. remain below the 2.66 percent average of the past 20 years even while the deficit has grown to 8.8 percent of the economy from 1 percent in 2007. Treasuries of all maturities returned 5.88 percent on average last year, including reinvested interest as the U.S. sold $2.2 trillion of notes and bonds, surpassing the $2.1 trillion record in 2009, Bank of America Merrill Lynch’s U.S. Treasury Master index shows.
Yields on 10-year Treasuries, which serve as a benchmark on everything from corporate loans to mortgages, were little changed at 3.32 percent last week. That compares with an average of 4.11 percent the past decade and the record low of 2.04 percent in December 2008. Bunds closed at 3.03 percent, gilts at 3.61 percent and Japanese bonds at 1.21 percent.
Ten-year Treasuries yielded 3.33 percent today as of 9:07 a.m. in London.
While investors are forcing European governments from Greece to Ireland to cut spending as governments prepare to sell $1.1 trillion of bonds this year, demand at Treasury auctions has been the highest on record.
The Treasury received about $2.99 in bids for each dollar of debt it sold in 2010, the highest ratio on record since at least 1994, when the government began releasing data for all maturities. That was up from $2.50 in 2009.
‘Fiscal Austerity’
Higher real yields in the U.S. than in Germany have given Obama the opportunity to add stimulus measures. Treasuries due in 10 years yielded 29 basis points, or 0.29 percentage point, than similar-maturity bunds on Jan. 14.
“We like Treasuries and our view is that they will outperform German bonds this year,” said Stuart Thomson, an international fixed-income fund manager at Ignis Asset Management in Glasgow, who oversees $110 billion in assets. “America is not a bankrupt country, and as the year progresses we are likely to see politicians there shifting from fiscal largesse to fiscal austerity.”
A 1.83 percent loss in December trimmed last year’s rally in Treasuries amid speculation the Fed’s bond purchases and an extension of federal tax cuts from Obama’s compromise with congressional Republicans will revive the economy.
‘Plug Our Noses’
The tax-cut extension will expand the federal budget deficit to $1.34 trillion for fiscal 2011, Credit Suisse Group AG strategists estimated on Dec. 7, a day after the president announced the agreement.
“We all have to plug our noses, dive in and accept the higher deficits,” said James Sarni, senior managing partner at Payden & Rygel in Los Angeles, which manages $56 billion. “People are willing to be patient because there is overriding sentiment and hope that Washington will have some credible deficit reduction plan in the future. But the first priority is making sure the economy does not slip back into a recession.”
Real yields aren’t enough to entice the manager of the world’s biggest bond fund. Pacific Investment Management Co.’s Bill Gross said investors should avoid dollar denominated assets as “mindless” spending may accelerate inflation, weaken the dollar and lose America’s AAA credit rating.
“The deficit, the debt level, the cost of that debt, ultimately bears a significant burden on an economy,” Gross said in an interview with Margaret Brennan on Bloomberg Television’s “InBusiness” program on Jan. 12.
‘No Clear Vision’
He estimated that if interest rates went up by 50 percent, or doubled, the deficit would probably expand by $300 billion to $400 billion.
“The problem is that politicians and citizens alike have no clear vision of the costs of a seemingly perpetual trillion dollar annual deficit,” Gross wrote in his January investment outlook. “As long as the stock market pulsates upward and job growth continues, there is an abiding conviction that all is well and that ‘old normal’ norms have returned. Not likely. There will be pain aplenty.”
Fed policy makers have held their target rate for overnight loans between banks in record low range of zero to 0.25 percent since December 2008 to fuel growth. They’re also purchasing as much as $600 billion of Treasuries through June to spur jobs and avoid deflation in a strategy called quantitative easing.
Government and central bank reports last week showed retail sales and industrial production rose in December. Purchases climbed 0.6 percent, capping the biggest annual increase in more than a decade, Commerce Department figures showed Jan. 14. Output at factories, mines and utilities jumped 0.8 percent, the most in five months, Fed data the same day showed.
Growth Estimates
Citigroup Inc. economists raised their 2011 gross domestic product forecast to a 3.4 percent increase from 3.1 percent, according to a Jan. 14 report. The euro-area’s economy will likely expand 2 percent this year, while Japan’s may grow 1.6 percent, according to Barclays Plc estimates.
Gains in corporate bonds, stocks, commodities and the dollar reflect optimism for faster growth. Yields on Investment- grade company notes fell to within 1.62 percentage points of Treasuries this month, the narrowest margin since early May and a sign of greater investor confidence in the economic outlook, according to Bank of America Merrill Lynch indexes.
The Standard & Poor’s 500 Index has advanced 26.5 percent from last year’s closing low on July 2, the Reuters/Jefferies CRB Index of raw materials is 33.9 percent higher than in May and IntercontinentalExchange Inc.’s U.S. Dollar Index is up 4.2 percent since November.
‘The Big Trap’
“There are structural headwinds to growth but if the U.S. can continue to grow, bondholders will feel better about deficit cuts going forward,” said Eric Pellicciaro, New York-based head of global rates investments at BlackRock Inc., which manages about $1 trillion in bonds. “The big trap Europe and Japan have is in the lack of confidence for above trend growth. Treasuries are looking good where they are on a relative basis.”
For all of 2010, consumer prices rose 1.5 percent, the smallest in two years, the Labor Department said Jan. 14. The core rate increase at 0.8 percent was the smallest since record- keeping began in 1958.
“The market is giving the benefit of the doubt to policy makers that congress and the administration have to come up with something to address structural problems,” said Scott Minerd, who helps oversee more than $100 billion in Santa Monica, California as Guggenheim Partners LLC’s chief investment officer. “We will continue to see real yields rise, which will continue to pull capital in to U.S. and dollar assets. Any rise in rates on 10-year notes, especially above 3.5 percent, we see as a buying opportunity.”
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