By Dakin Campbell and Daniel Kruger
Feb. 10 (Bloomberg) -- The bond vigilantes may be making a comeback.
A decade after forcing Bill Clinton to abandon his spending plans in favor of a balanced budget, investors in Treasuries are bedeviling President Barack Obama as he embarks on the most costly spending plan in U.S. history, driving up borrowing costs for the government and consumers.
Treasuries have lost 3.6 percent this year, their worst annual start since 1980, according to Merrill Lynch & Co.’s Treasury Master Index data. Yields climbed on longer-maturity debt in five of the past six weeks as bond prices fell amid concern that the Federal Reserve may not buy U.S. debt to keep yields low while the government increases its borrowing.
“The bond vigilantes are testing” the administration and Fed policy makers, said Tom di Galoma, managing director of government bonds at Jefferies & Co., a brokerage for institutional investors in New York.
Ten-year note yields, which help determine rates on everything from mortgages to auto loans, rose as much as 1 percentage point from a record low of 2.035 on Dec. 18. That was two days after the Fed said it was “evaluating the potential benefits of purchasing longer-term Treasury securities” as a way to keep consumer borrowing costs from rising.
Latest Pledge
Treasuries rose today after Treasury Secretary Timothy Geithner’s plan to rescue the banking system fell short of expectations, boosting demand for the safety of government debt. Geithner pledged government financing for programs aimed at spurring new lending and addressing banks’ toxic assets, an effort that may grow to as much as $2 trillion.
The yield on the 10-year note tumbled 12 basis points, or 0.12 percentage point, to 2.88 percent at 12 p.m. in New York, according to BGCantor Market Data. The price of the 3.75 percent security maturing in November 2018 climbed 1, or $10 per $1,000 face amount, to 107 12/32. The yield touched 3.05 percent yesterday, the highest in almost 11 weeks.
Since Dec. 31, yields on 10-year notes have increased 67 basis points, or 0.67 percentage point, while those on the 30- year bonds have soared 89 basis points to 3.57 percent.
Investors are also selling Treasuries as credit markets begin to thaw, lessening the need for the haven of government debt. Three-month Treasury bill rates have climbed to 0.31 percent after touching minus 0.04 percent Dec. 4. That flight to safety helped U.S. debt rally 14 percent in 2008, the best performance since gaining 18.5 percent in 1995, Merrill Lynch indexes show.
A Vigilante
“The scarcity and the fear that were driving the bond market are unwinding,” said E. Craig Coats Jr., the head of Salomon Brothers’ government securitiesdesk when it was the world’s biggest bond trader.
Coats, who is now co-head of fixed income at Keefe, Bruyette & Woods Inc. in New York, said he considers himself one of the original vigilantes, the bearish traders who drove up long-term interest rates and persuaded Clinton to place deficit- reduction above fulfilling his spending promises.
The economic stimulus package sought by Obama cleared a key procedural hurdle in the U.S. Senate yesterday. The chamber voted 61 to 36 to bring debate on the $827 billion measure to a close, a precursor to a vote on the bill itself scheduled for today.
To help pay for the plan the Treasury will likely borrow a record $2.5 trillion this fiscal year ending Sept. 30, almost triple the $892 billion in notes and bonds sold in fiscal 2008, according to Goldman Sachs Group Inc. The New York-based firm is one of the 17 primary dealers that are required to bid at the government’s debt auctions.
This week, the Treasury Department will sell $187 billion of bills, notes and bonds.
‘Never Ending’
“The supply is never ending,” said Jamie Jackson, who oversees governmentdebt trading at RiverSource Investments in Minneapolis. The firm manages $90 billion of bonds.
The last time investors drove yields up from such low levels was 2003, when policy makers also commented on buying Treasuries as a way to cap borrowing costs. Yields rose 152 basis points to 4.59 percent on Sept. 3 from a 45-year low of 3.07 percent on June 16 as traders and investors gave up on the idea of Fed purchases after then Fed Chairman Alan Greenspan said July 15 that the central bank was unlikely to buy government debt.
“In the end they didn’t pull the trigger,” said Vincent Reinhart, the Fed’s formerdirector of monetary affairs and resident scholar at the American Enterprise Institute in Washington. “The markets got ahead of the Fed and the Fed didn’t follow.”
‘Challenging the Fed’
This time around, investors are once again challenging the Fed to buy Treasuries or watch U.S. borrowing costs increase.
“To some degree it’s challenging the Fed,” said David Ader, head of U.S.government bond strategy at Greenwich, Connecticut-based RBS Greenwich Capital, one of the 17 primary dealers. “You can only presume that the trigger is going to be levels higher than we’ve seen them,” he said in reference to yields.
The so-called bond vigilantes torpedoed President Bill Clinton’s efforts to boostdeficit spending in favor of a balanced budget.
The resulting rise in yields led Clinton political adviser James Carville to observe at the time: “I 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.”
Fear and Fundamentals
The cost to protect U.S. government debt against losses is higher than that of France, according to traders of credit- default swaps. Contracts on five-year credit default swaps tied to Treasuries rose to 85 basis points from 67.4 basis points Dec. 31, according to CMA Datavision in London. The cost to insure France’s debt is 70 basis points.
Credit-default swaps, contracts conceived to protect bondholders against default, pay the buyer face value in exchange for the underlying securities or the cash equivalent should a company fail to adhere to its debt agreements.
“A large portion of the rally last year was based on fear rather than fundamentals and we are unwinding that fear trade now,” said Thomas Sowanick, who manages $20 billion as chief investment officer of Princeton, New Jersey-based Clearbrook Financial LLC and the former chief global debt strategist at Merrill Lynch. “We are also starting to build in a premium for the huge financing bill that is going to come this year.”
To contact the reporters on this story: Dakin Campbell in New York atdcampbell27@bloomberg.net; Daniel Kruger in New York atdkruger1@bloomberg.net
