By Daniel Kruger and Dakin Campbell
Dec. 2 (Bloomberg) -- Thirty-year Treasury bonds are returning the most since 1995 as investors bet the Federal Reserve will buy the securities to help bring down long-term borrowing costs.
The so-called long bond has returned 27.8 percent this year, including a 15.6 percent gain in November, Merrill Lynch & Co. index data show. The debt is poised for the best annual performance since rallying 34 percent 13 years ago.
Yields touched 3.1825 percent yesterday, the lowest since the U.S. began regular auctions of the securities in 1977, after Fed Chairman Ben S. Bernankesaid he has “limited” room to lower interest rates further below 1 percent and may use less conventional policies, such as buying Treasuries. Even investors who say bonds are expensive are enticed to buy the debt for fear of missing out on even more gains.
“We’re on new ground,” said Barr Segal, a managing director at Los Angeles-based TCW Group Inc., which oversees $90 billion in fixed-income assets. “You just wonder if you’re going to be the last man in.”
The yield on the benchmark 30-year bond rose 8 basis points to 3.28 percent at 9:15 a.m., according to BGCantor Market Data. The price of the 4 1/2 percent security due May 2038 fell 1 21/32, or $16.56 per $1,000 face amount, to 123 2/32. A basis point is 0.01 percentage point. The yield is down from 4.45 percent at the end of 2007.
‘Bubble’ Phase
Bonds rallied even after David Rosenberg, the chief North American economist at New York-based Merrill, said yesterday that demand for Treasuries had reached the “bubble” phase like in technology stocks in 2000 and real estate six years later.
Rosenberg was one of only 11 economists out of 51 surveyed by Bloomberg at the start of the year to predict that yields would fall. Yields on 30-year bonds were forecast to climb to 4.70 percent by the end of this year, according to the median estimate. Rosenberg, who estimated a yield of 4.05 percent, now sees it rising to 3.60 percent by the end of 2009, according to a survey conducted from Nov. 3 to Nov. 11.
The decline in yield for the 30-year bond yesterday was the biggest since Nov. 20, when the Fed announced it would buy $100 billion in debt issued by government-chartered companies such as Fannie Mae and Freddie Mac, and $500 billion in mortgage-backed securities issued by the companies.
The rally pushed 30-year bond yields to within 2.31 percentage points of those on two-year notes. The so-called spread shrunk from the peak this year of 3.12 percentage points on Nov. 13, suggesting more gains may be possible for longer- maturity debt after Bernanke’s comments. The gap has averaged about 1.5 percentage points this decade.
‘Convexity Trades’
Traders are also buying 30-year bonds on speculation the Fed’s purchases may drive mortgage rates lower, spurring homeowners to refinance their home loans and reducing the average maturity, or duration, of mortgage bonds.
A sudden drop in duration can cause losses for mortgage investors because it means they are receiving their money back sooner than anticipated, forcing them to reinvest at lower rates. To hedge against losses and to increase the duration of their holdings, they’ll typically buy Treasuries. The yield on Fannie Mae’s 30-year current coupon mortgage securities fell 11 basis points to 4.72 percent yesterday, from 4.83 percent Nov. 28.
“The ball got rolling last week,” said Chris Ahrens, an interest-rate strategist at UBS Securities LLC in Greenwich, Connecticut, one of 17 primary dealers that trade with the central bank. “The trade has fed upon itself with the continued weak economic information that we saw today.”
Mortgage Refinance
Homeowners will soon be able to refinance 59 percent of all mortgages outstanding, likely making hedging an ongoing issue, said Fidelio Tata, head of derivatives strategy at RBS Greenwich Capital in Greenwich, Connecticut.
With yields on 30-year current coupon securities dipping below 4.90 percent, mortgages with a 5.5 percent interest rate are now able to be refinanced, while those with a 5 percent rate will soon be eligible, he wrote in a Nov. 25 report.
The last time the 30-year bond rallied as much as it has this year was 1995, as optimism grew that the Clinton administration was poised to turn budget deficits into surpluses, allowing the government to reduce debt sales. Form a shortfall of $163.9 billion in 1995, the deficit narrowed each year until 2000, when the U.S. recorded a $236.9 billion surplus.
This year’s surge comes amid different circumstances, as the government is expected to post a deficit in excess of $1 trillion as it attempts to fund bailouts for banks and fiscal stimulus programs to jump start economic growth.
Inflation Slowdown
Yields at current levels “do not command outstanding investment value,” Jack Malvey, a fixed-income strategist at Barclays Capital in New York, said in a report to the firm’s clients yesterday. “Not with $1.0 trillion plus U.S. government deficits and incremental Treasury supply looming as far as the eye can see.”
A slowdown in inflation as the economy shrinks makes bonds more valuable, even with yields at record lows.
The breakeven rate, or the difference in yield between 30- year Treasury Inflation-Protected Securities and U.S. bonds, is 0.80 percentage point, suggesting investors see few signs of inflation. It touched 0.56 percentage point on Nov. 26, the lowest since the Treasury began sales of the securities in 1998.
The U.S. economy “will probably remain weak for a time,” even if the credit crisis eases, Bernanke said during yesterday’s speech in Austin, Texas. While the Fed can’t push interest rates below zero, “the second arrow in the Federal Reserve’s quiver -- the provision of liquidity -- remains effective,” he said.
To contact the reporters on this story: Daniel Kruger in London atdkruger1@bloomberg.net; Dakin Campbell in New York atdcampbell27@bloomberg.net.
