Treasuries Drop, Head for 4th Monthly Loss as Recession Eases

Treasuries Drop, Head for 4th Monthly Loss as Recession Eases


July 31 (Bloomberg) -- Treasuries fell, heading for a fourth monthly loss, before a report that economists said will show the deepest U.S. economic recession in 50 years is easing.

The longest monthly Treasury market decline since 1996 is being fueled by record U.S. debt sales as President Barack Obama borrows unprecedented amounts to fund his stimulus programs. Treasury issuance will increase to $446 billion this quarter, up 30 percent from the prior three months, according to a survey by the Securities Industry and Financial Markets Association.

“It’s a tough time for the Treasury market,” said Tsutomu Komiya, an investor in Tokyo at Daiwa Asset Management Co., part of Japan’s No. 2 brokerage, which oversees the equivalent of $101.6 billion. “There is a lot of supply coming and signs of improvement in the economy are starting to materialize.”

The yield on the 10-year note rose three basis points to 3.64 percent as of 6:37 a.m. in London, according to BGCantor Market Data. The price of the 3.125 percent security maturing in May 2019 fell 1/4, or $2.50 per $1,000 face amount, to 95 26/32.

The yield increased 11 basis points, or 0.11 percentage point, this month. It will climb to 3.70 percent by year-end, according to a Bloomberg News survey of economists with the most recent forecasts given the heaviest weightings.

Government securities handed investors a 0.3 percent loss in July as of yesterday, according to Merrill Lynch & Co.’s U.S. Treasury Master index.

Annual Loss

Treasuries are down 4.7 percent in 2009, while the MSCI World Index of shares returned almost 15 percent. German government bonds rose 0.2 percent during the period, while Japanese securities delivered a 0.4 percent loss, the Merrill figures show.

U.S. gross domestic product contracted at a 1.5 percent annual rate from April to June, after dropping 5.5 percent in the previous quarter, according to the median forecast of 78 economists surveyed by Bloomberg News before the Commerce Department report today.

The projection for net issuance of U.S. bills, notes and bonds is the median forecast in a quarterly poll of SIFMA member firms representing primary dealers, the New York-based association said in a statement yesterday. Eighteen primary dealers trade government debt with the Federal Reserve and are required to participate in Treasury auctions.

Goldman Sachs

Goldman Sachs Group Inc., one of the dealers, predicts the U.S. will sell about $2.9 trillion of debt in the two years ending Sept. 30, 2010, representing a 28 percent cut from the brokerage’s previous estimate as the nation’s economic prospects improve. The U.S. financing need is “still huge,” Goldman said in its report this week.

Obama is depending on overseas investors to help finance its debt.

The Fed’s custodial holdings of Treasuries for overseas accounts including foreign central banks reached $2 trillion for the first time, about a third of the $6.61 trillion of U.S. marketable debt.

The holdings rose by $5.38 billion, or 0.27 percent, in the week ended July 29, according to data released yesterday by the Fed Bank of New York. Custodial holdings have climbed 18 percent this year, after surging 39 percent in 2008, the data show.

The last time Treasuries slid for four months was from February to May of 1996, amid signs of growth in the economy. Government debt also fell then on speculation Fidelity Investments’ Magellan fund, at the time the largest mutual fund in the U.S., was preparing to sell following the resignation of manager Jeffrey N. Vinik, whose bets on bonds dragged down returns.

Investors spent July adding to wagers that inflation will quicken as the economy improves, yields indicate.

Corporate Bonds

The difference between rates on 10-year notes and Treasury Inflation Protected Securities widened to 1.89 percentage points from this month’s low of 1.49 percentage points set July 13. The spread represents the outlook among traders for consumer prices for the next decade.

Investors looking for higher yields than those available in the Treasury market are driving a rally in corporate bonds.

Merrill’s U.S. Corporate & High Yield Master index returned 3.4 percent in July, and it is up 16 percent in 2009, headed for its best year since the firm started tracking the figure in 1997.

The cost of protecting corporate and sovereign bonds in Asia and the Pacific from default declined today, according to traders of credit-default swaps.

Credit Quality

The Markit iTraxx Asia index of credit-default swaps on 50 investment-grade borrowers outside Japan fell four basis points to 1.275 percentage points, Royal Bank of Scotland Group Plc prices show.

Credit-default swap indexes are benchmarks for protecting bonds against default and traders use them to speculate on credit quality. An increase suggests deteriorating perceptions of credit quality and a drop shows improvement. The swaps are contracts that pay the buyer face value if a borrower fails to adhere to its debt agreements.

Pacific Investment Management Co., which runs the world’s biggest bond fund in Newport Beach, California, and Franklin Templeton Investments, the mutual fund company that oversees $450 billion in San Mateo California, both recommended high- grade corporate bonds this week.

Yields in other parts of credit markets suggest that Fed efforts to revive trading that froze last year are meeting some success.

The difference between what banks and the Treasury pay to borrow money for three months, the so-called TED spread, narrowed to 0.31 percentage points from 2008’s high of 4.64 percentage points in October.

Pricing Rate Hikes

Two-year notes, among the most sensitive to what the Fed does with interest rates, lagged behind 10-year securities this week on speculation the central bank will increase borrowing costs in 2010.

“The market is pricing in the Fed to hike in early 2010,” Barclays Capital Inc. wrote in a report yesterday by strategists including Ajay Rajadhyaksha in New York. Barclays is another primary dealer.

Two-year yields rose two basis points today to 1.19 percent, approaching the highest level in six weeks.

The difference between two- and 10-year yields narrowed to 2.44 percentage points, near a three-week low.

Two-year notes yield 94 basis points more than the upper end of the Fed’s target for overnight loans between banks, the most in more than a month. Fed Chairman Ben S. Bernanke cut the rate to a range of zero to 0.25 percent in December.

bloomberg