26 Oct 2009
Oct. 26 (Bloomberg) -- Treasury Secretary Timothy Geithner's plans to lock in near record-low borrowing costs in 2010 may mean a second year of losses on longer-term bonds.After selling $1.9 trillion of short-term securities to finance President Barack Obama's efforts to end the worst recession since the 1930s, the Treasury plans to lengthen the average due date of its outstanding debt to 72 months from a 26- year low of 49 months. That may mean boosting sales of 10- and 30-year bonds by 40 percent over the next year to $600 billion, according to FTN Financial in Memphis, Tennessee, driving down prices of longer-term securities.
"We should be trying to term it out," said Mitchell Stapley, the Grand Rapids, Michigan-based chief fixed-income officer for Fifth Third Asset Management who oversees $22 billion, and not expose "this burgeoning debt issuance that we've got ahead of us to potentially higher interest rates."
Replacing bills with bonds may drive up the so-called yield curve as the Federal Reserve keeps its target rate for overnight loans between banks unchanged near zero until the second half of 2010, according to the weighted average of 67 forecasts in a Bloomberg survey. The gap between yields on 2-year and 10-year notes widened to 2.49 percentage points last week, compared with an average of 0.8 point since 1977.
While a so-called steeper yield curve is usually a sign of diminishing demand from investors anticipating faster economic growth and inflation, coupons on bonds near the lowest on record show there's no lack of appetite for government debt following this year's record sales. Bond investors are on track for the biggest annual loss since at least 1978, according to Merrill Lynch & Co. index data.
Falling Interest Expense
Treasury has sold $1.6 trillion in notes and bonds to finance a budget deficit that reached a record $1.4 trillion in fiscal year 2009 that ended Sept. 30. Debt amounted to 9.9 percent of the nation's economy, triple the size of the 2008 shortfall.
At the same time, interest paid by the U.S. dropped $67.8 billion even as outstanding debt rose 34 percent to $7 trillion from $5.21 trillion, government data shows. Yields on 10-year Treasuries ended last week at 3.48 percent, less than half the average of 7.31 percent over the past 40 years.
The steeper yield curve will help banks recapitalize after $1.66 trillion in losses and writedowns since the start of 2007 as they borrow shorter-term and invest in the longest-maturity debt, profiting from the difference in yields.
Bank Earnings
JPMorgan Chase & Co., the second-largest U.S. bank by assets, said Oct. 14 that third-quarter profit rose almost sevenfold to $3.59 billion from a year earlier, as the New York company's fixed-income revenue surged. A day later, Goldman Sachs Group Inc., also in New York, said net income more than doubled to $3.19 billion on trading gains and investments with the its own money.
Yields on 10-year Treasuries, up from 2.04 percent in December, will jump to 4.19 percent by 2011, according the weighted average estimate of 57 economists and strategists surveyed by Bloomberg News. Two-year yields are 1.02 percent today, compared with 0.76 percent at the end of 2008.
U.S. government securities due in 10 years or more are on pace to lose 12.7 percent in 2009, compared with a loss of 1.4 percent for shorter-maturity notes, including reinvested interest, Merrill Lynch bond indexes show.
Payden & Rygel, BlackRock Inc. and Fifth Third say the extra supply may cause returns on longer-maturity Treasuries to lag behind shorter-term debt for a second consecutive year, the first time that has happened since at least 1988, according to the Merrill Lynch indexes.
Consumer Borrowing Costs
An investor with $100 million in 10-year notes would lose almost $1 million if yields rise to the survey target by the end of 2010, according to Bloomberg data.
Higher yields may also hinder Fed Chairman Ben S. Bernanke's efforts to cap consumer borrowing rates, his goal at the start of 2009, to lift the economy from its worst slump since the Great Depression.
The Libor-OIS spread, a gauge of banks' lending reluctance, has narrowed to 0.12 percentage point from as high as 3.64 percentage points in October 2008. Borrowing costs for individuals have fallen, too, with 30-year fixed mortgage rates declining to 5.15 percent on Oct. 22 from 5.74 percent in June, according to Bankrate.com in North Palm Beach, Florida.
"Rates moving up dramatically at this time would be the last thing they would want to see," said James Sarni, senior managing partner at Los Angeles-based Payden & Rygel, which manages $50 billion. "The outlook for rates is higher because of this supply demand issue."
Difficult to Tighten
Concerns that rising supply will push yields higher are overblown, said Thomas Atteberry, who manages $3.5 billion in fixed income assets at First Pacific Advisors in Los Angeles.
Without economic growth, an improving outlook for employment and rising consumer prices it will be difficult for the Fed to justify raising borrowing costs, he said. Ten-year note yields may stay within their present range of 3 percent to 4 percent, he said.
The U.S. has lost 7.2 million jobs since the recession began in December 2007, including a 263,000 drop in September payrolls. The difference between yields on 10-year notes and Treasury Inflation Protected Securities of the same maturity, which reflects the outlook among traders for consumer prices through 2011, ended last week at 2 percentage points. The rate of inflation rose 2.87 percent on average between 2002 and 2008.
A report from the Federal Reserve Bank of Cleveland last week said the yield curve suggests growth of 2.3 percent over the next 12 months.
Faster Growth
Gross domestic product increased at a 3.2 percent annual rate from July through September, according to the median estimate in a Bloomberg News survey, after shrinking 6.4 percent in the first quarter and 0.7 percent in the second. Growth will slow to 2.4 percent this quarter and 2.5 percent in the first three months of 2010, according to the median estimate of economist surveyed by Bloomberg.
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. About 23 percent, or $1.63 trillion of the Treasury's $7 trillion in outstanding public debt, will mature next year, Bloomberg data shows.
"Extending the average length at this time to bear the brunt of longer term structural shifts in the deficit while increasing capacity in the front end of the curve to address unexpected borrowing needs is prudent," Karthik Ramanathan, the Treasury's acting assistant secretary for financial markets, said in an Oct. 1 speech in Boston. The average maturity "is expected to stabilize at six to seven years," he said.
Average Maturity
The government may reach the average maturity of six years by doubling sales of 30-year bonds to $250 billion and raising 10-year notes by a third to $350 billion, according to FTN. Those maturities would need to account for 32 percent of all auctions to achieve an average maturity of 6.5 years, up from 18 percent currently, FTN estimates.
"There's going to be a lot of Treasury supply," said Stuart Spodek, co-head of U.S. bonds in New York at BlackRock, which manages $539.6 billion in debt. "The easy money has been made."
