March 9 (Bloomberg) -- As the recession and the credit freeze worsen, even U.S.government bonds are no refuge for investors, except for owners of two-year Treasury notes.
Treasuries, the traditional haven in times of financial stress, are off to the worst start to a year since 1980, according to Merrill Lynch & Co. indexes. Prices are falling, led by the 12.7 percent drop in30-year bonds, because the government needs to finance the $11.7 trillion bailout of the U.S. banking system and another $787 billion for President Barack Obama’s economic rescue package that may increase the federal budget deficit to $1.75 trillion in fiscal 2009.
Only two-year notes haven’t lost money this year, according to Merrill indexes, which include interest payments and price changes. While Goldman Sachs Group Inc. estimates the U.S. will almost triple debt sales this year to a record $2.5 trillion, yields on shorter-term notes are likely to rise less than longer- maturity securities because Treasury plans to lengthen the average maturity of its debt, now the lowest in 26 years.
“This is one of those environments where playing good defense will win the game,” said Thomas Girard, a money manager who helps oversee $110 billion in fixed-income assets at New York Life Investment Management in New York. “Owning a two-year Treasury is a low risk way to earn something on your money.”
The government sold $1.9 trillion of debt maturing in one- year or less in the fourth quarter to pay for efforts to stem the collapse of the world’s biggest financial companies, which reported almost $1.2 trillion of losses and writedowns since the start of 2007.
‘Terrible Mistake’
The average maturity of U.S. debt fell to 49 months in the fourth quarter, the lowest since reaching 48 months in the second quarter of 1983, when yields were dropping from the record highs set in 1981. Now, Treasury may have to refinance almost half its $6 trillion of debt over the next year.
“They have made a terrible mistake with their debt management,” said Jim Bianco, president of Chicago-based Bianco Research LLC.
Jenni Engebretsen, a Treasury spokeswoman in Washington, declined to comment on debt management policies. The department said last month that it plans to boost the average maturity to 52 months in the next five years, which will require more sales of longer-term notes and bonds. The government forecasts that the amount of debt due in 12 months will drop to about 33 percent through 2013, from about 44 percent Dec. 31.
Consumer Borrowing Costs
Notes maturing in 10 years or more fell 7.2 percent since December, while two-year notes were little changed, according to Merrill index data. The yield on notes due in February 2011 ended last week at 0.95 percent, up from 0.76 percent at the start of the year. For 10-year notes, yields rose to 2.87 percent from 2.21 percent at the end of December.
Two-year yields fell one basis point to 0.93 percent and 10- year yields were little changed at 2.87 at 7:55 p.m. in New York.
Increasing yields on longer-term debt may undermine Federal Reserve Chairman Ben S. Bernanke’s efforts to close the gap between consumer borrowing costs and rates available to banks that he says is essential for restoring financial markets and the economy to health.
“Without a reasonable degree of financial stability, a sustainable recovery will not occur,” Bernanke told the Senate Budget Committee last week.
Government loans, spending or guarantees to rescue the country’s financial system already total more than $11.7 trillion, according to data compiled by Bloomberg.
Rescue Programs
While financial institutions can borrow almost for free from the Fed and through the more than a dozen rescue programs established since credit markets froze in August 2007, consumer rates haven’t approached the same record lows.
The difference between rates on 30-year fixed-cost mortgages and 10-year Treasuries was 2.27 percentage points on March 6, according to data compiled by Bloomberg. The gap averaged 1.75 percentage points in the 10 years before the subprime-mortgage collapse.
Higher Treasury yields may also increase borrowing costs for companies. Yields on corporate bonds relative to government rates are still five times what they were before the credit crisis began, Merrill indexes show.
Companies are paying punitive rates to raise money. Basel, Switzerland-based drugmaker Roche Holding AG sold $32.4 billion of debt last month. The discounts on the debt provided buyers with profits of about $775 million in less than two weeks, according to data compiled by Bloomberg.
Expand Purchases
The central bank may purchase longer-term securities to keep a lid on yields,Bernanke said on Dec. 1. Federal Reserve Bank of New York President William Dudley said March 6 that policy makers have decided for now not to expand the range of securities they purchase.
Treasuries provided the only safety from the rout in financial markets in 2008. The 30-year bond was the best performer, returning 41 percent, according to Merrill indexes.
This year, the Standard & Poor’s 500 Index has lost 24 percent, whileReuters/Jefferies CRB Index of commodity prices dropped 8.7 percent as the U.S. economy deteriorates. American companies from General Motors Corp. to Sears Holdings Corp. fired 651,000 workers in February, the Labor Department said March 6. The economy shrank at a 6.2 percent pace in the fourth quarter of 2008, the weakest performance since 1982.
Front End
“From our perspective the front end is the place to take any risk,” said Carl Lantz, an interest-rate strategist in New York at Credit Suisse Securities USA LLC, one of the 16 primary dealers of U.S. government securities that are obligated to bid at the Treasury’s debt auctions. “The long end is volatile and random and with the front end you know what you’re getting,” he said in a March 4 telephone interview.
Treasury officials started to reduce the reliance on shorter-term debt last month when they kept the two-year note auction unchanged at $40 billion and boosted sales of longer-term debt. The government issued a record $21 billion in 10-year notes Feb. 11, up $5 billion from January’s auction.
“We expect two-year supply to increase only marginally in absolute terms but continue to decrease as a percentage of total coupon supply,” Michael Pondand Anshul Pradhan, fixed-income strategists at Barclays Capital in New York, another primary dealer, wrote in a report to clients Feb. 26.
Last month, Treasury also brought back the seven-year note for the first time since 1993, in a $22 billion sale. The government said it will increase auctions of 10-year notes to 12 times a year from eight, and 30-year bonds eight times a year, from four. The Treasury will sell $34 billion in three-year notes, $18 billion in 10-year notes and $11 billion in 30-year bonds this week.
Spread to Funds
While government bond sales are increasing, borrowing costs have declined this fiscal year because of last year’s plunge in interest rates and the Treasury’s ability to sell bills due in one year or less at rates near zero percent. Interest paid by the Treasury in the fiscal year that started in October dropped 12 percent from a year earlier to $138.5 billion, government figures show.
The Fed’s decision in December to lower its target rate for overnight loans between banks to a range of zero to 0.25 percent may provide profit opportunities in shorter-term Treasuries. Two- year notes yield about 70 basis points more than the Fed’s target rate, compared with the 45 basis point average over the past 20 years, according to data compiled by Bloomberg.
“The carry on that is meaningful in an environment where the Fed isn’t likely to tighten anytime soon,” said Michael Cloherty, head of U.S. interest-rate strategy in New York at Banc of America Securities-Merrill Lynch, in a March 4 telephone interview. “That’s not a bad income stream.”
To contact the reporters on this story: Dakin Campbell in New York atdcampbell27@bloomberg.net.
