The world's biggest bond dealers dispute Bill Gross's assertion that the $9.13 trillion market for U.S. Treasuries offers little value.
While Gross, who runs Pacific Investment Management Co.'s $236 billion Total Return Fund, is betting against government debt, the 20 firms that trade with the Federal Reserve predict yields on the benchmark 10-year Treasury note will hold below 4 percent for a third straight year for the balance of 2011.
“I could join the dealers and say the 10-year's not going to go to 4 percent, so what am I left with?” Gross said in a telephone interview April 20. “I'm left with an under-yielding, less-than-inflation security. I have better choices. As a firm we're not going to put up with it.”
So far, Goldman Sachs Group Inc., Credit Suisse Group AG and the rest of the primary dealers are proving right. U.S. bonds of all maturities are generating their best returns since August, gaining 0.49 percent this month. Optimism Congress will cut spending, slower growth and rising demand from banks meeting tighter risk standards governing the capital they must hold to cushion against losses are supporting bond prices.
Yields on 10-year notes ended last week at 3.39 percent, down from this year's high of 3.77 percent on Feb. 9, even as Standard & Poor's cut its outlook for the U.S.'s top AAA credit rating to “negative” from “stable.” S&P said the move indicates a one-in-three chance of a downgrade.
‘Significant Demand'
“What's telling is the significant volume of buying when 10-year yields were above 3.50 percent and 30-year bond yields were around 4.65 percent,” said William O'Donnell, head U.S. government bond strategist at RBS Securities Inc. in Stamford, Connecticut, a primary dealer. “There's still significant demand for long-end Treasury paper at those levels and I don't think Bill Gross is going to make that demand disappear.”
Demand at Treasury auctions has risen to record levels this year, with investors submitting $3 in orders for every $1 of debt offered, data compiled by Bloomberg show. At this month's auctions of three-, 10- and 30-year bonds, the so-called bid-to- cover ratio exceeded the average of the previous 10 sales.
RBS forecasts yields will fall to 3.25 percent by June 30, before ending the year at 3.6 percent. Goldman Sachs, the most accurate bond forecaster in the 13 quarters ended March 31 based on data compiled by Bloomberg, sees them at 3.5 percent in June and 3.75 percent in December.
‘Easier' Policy
“Increased downgrade risk doesn't necessarily imply increased Treasury yields,” Goldman Sachs economists led by Jan Hatzius in New York wrote in an April 19 report. “A significant push toward fiscal austerity would lead to lower growth and lower growth would lead to easier monetary policy for longer.”
Fed policy makers, who meet this week, will likely keep their target interest rate for overnight loans between banks in a record low range of zero to 0.25 percent through year-end, according to the median estimate of more than 75 economists surveyed by Bloomberg. A separate poll show the economists reduced their 2011 growth estimates to 2.9 percent from 3.2 percent in February.
Ten-year yields fell almost 2 basis points, or 0.02 percentage point, last week, according to Bloomberg Bond Trader prices. The 3.625 percent security due February 2021 rose 3/32, or 94 cents per $1,000 face amount, to 101 28/32.
The yield was little changed at 3.39 percent today as of 1:27 p.m. in Tokyo.
Competing Proposals
The split between Gross and the dealers comes as President Barack Obama and Republicans in Congress debate competing proposals to reduce the $1.4 trillion budget deficit.
Obama has proposed $4 trillion in spending cuts within 12 years through a combination of reduced expenditures and tax increases. The Republican-controlled House passed a budget April 15 that would trim spending by more than $6 trillion over a decade and slash government support of Medicare and Medicaid.
With the supply of marketable Treasuries outstanding having more than doubled to $9.1 trillion since the start of the financial crisis in August 2007, the political moves are so far insufficient for Gross.
“This no Treasury thing is simply a demonstration of vigilance on the part of Pimco that says these bonds aren't worth what others appear to think they're worth, and we prefer another menu, that's all,” Gross said.
Eliminated Treasuries
Gross eliminated Treasuries from his fund in February and then, in March, bet that the debt will lose value, according to the firm's holdings statement released April 11. The Total Return Fund has averaged an 8.65 percent gain the past five years, beating 99 percent of its peers, Bloomberg data show.
While Pimco's $1.24 trillion in assets under management commands the attention of investors, foreign central banks and sovereign wealth funds exert a bigger day-to-day pull on Treasury yields, said John Fath, who manages $2.5 billion at BTG Pactual in New York.
[More: Legendary fund manager goes from penthouse to outhouse]
“Gross's point is well-taken and ultimately I think he will be right,” said Fath, former head of Treasury trading at primary dealer UBS AG. Even so, “if these guys are willing to hold these securities at these levels, it's going to be hard to see rates go up,” he said in reference to overseas investors.
Foreign holdings of Treasuries jumped $36.4 billion to $4.47 trillion in the first two months of the year, according to the Treasury. U.S. financial markets should be stable over the long term, even after S&P's warning, Xia Bin, an adviser to the Chinese central bank, said last week.
Increasing Holdings
Banks have increased their holdings of Treasuries and agency securities by $49.1 billion to $1.67 trillion since the end of last year, according to Fed data. The Basel Committee on Banking Supervision, appointed by the Swiss government, proposed rules in October requiring banks to increase available capital under the so-called Basel III rules.
While commercial and industrial loans rose to $1.25 trillion this month from $1.21 trillion in September, they remain below the peak of $1.62 trillion in October 2008, Fed data show.
Banks may boost their purchases as they reinvest the proceeds of maturing loans and non-government bonds, according to Laurence Fink, chairman and chief executive officer of New York-based BlackRock Inc., which manages $3.65 trillion.
“Banks are going to have their C&I loans and their structured bonds rolling off to the tune of $2 trillion,” Fink said April 19 on Bloomberg Television's InsideTrack with Erik Schatzker. “Banks may be a big buyer of Treasuries.”
End of QE2
The end of the Fed's second-round of so-called quantitative easing may not be enough to spark a sell-off. The $600 billion bond-purchase program wraps up in June, and the Fed is likely to signal at the conclusion of this week's meeting it will continue to reinvest the proceeds of maturing mortgage securities in Treasuries, said Neal Soss, chief economist at Credit Suisse.
“We do not view the end of QE2 as a reason for rates to spike,” Nomura strategists led by George Goncalves wrote in a report published April 19. “If the markets behave according to prior QE experience, we should see the curve flatten and rates stay in check.”
A flatter yield curve would mean a smaller difference between short- and long-term bond rates. Ten-year notes yield 2.73 percentage points more than two-year securities, compared with the mean of 1.16 percentage points since 1991.
In its first round of bond purchases the Fed bought $1.7 trillion of mortgage and Treasury securities in 2009 and the first quarter of 2010. Within three months of that program ending, 10-year yields fell to 2.93 percent from 3.83 percent.
HSBC Holdings Plc has the most bullish year-end yield forecast among the primary dealers at 3.4 percent, followed by Societe Generale at 3.5 percent, according to a survey by Bloomberg News. Jefferies Group Inc. has the most bearish call at 5 percent, followed by BNP Paribas' 4.25 percent.
--Bloomberg News--
