The 18 primary dealers that trade with the Federal Reserve reported that holdings of U.S. government debt tumbled to a net $2.34 billion on Dec. 29 from $81.3 billion on Nov. 24, the most since June 2009, according to the most recent central bank data. While the stake is the lowest since February, corporate bond and mortgage securities have risen from the lows of the year.
Dealers had stocked up on U.S. debt anticipating demand from customers who wanted to sell the securities to the central bank as part of Fed Chairman Ben S. Bernanke’s plan to buy $600 billion of Treasuries. Government bonds lost their allure as stocks rose, corporate financing conditions eased, expectations for inflation increased and the dollar strengthened.
Berkshire Hathaway Inc., the Omaha, Nebraska-based holding company controlled by billionaire Warren Buffett, and General Electric Co.’s finance unit led companies selling a record $48.5 billion of bonds in the U.S. last week as relative yields on investment-grade debt shrank to the narrowest since May.
Dealers typically pare Treasuries holdings as company debt sales accelerate, according to Mitchell Stapley, the Grand Rapids, Michigan-based chief fixed-income officer for Fifth Third Asset Management, which oversees $22 billion. This represents “the normal functioning of the market,” he said.
Prospects for faster economic growth caused Treasuries to lose 2.67 percent last quarter, including reinvested interest, trimming the annual gain to 5.88 percent for 2010, Bank of America Merrill Lynch’s U.S. Treasury Master index shows. Company bonds lost 0.57 percent in the three months ended Dec. 31, cutting their annual gain to 10.8 percent.
Yields on 10-year Treasuries, which serve as a benchmark on everything from corporate loans to mortgages, rose 3 basis points to 3.32 percent last week. Primary dealers forecast the yield will climb to 3.65 percent by the end of the fourth quarter, a Bloomberg News survey last month showed. Yields dropped as low as 2.33 percent on Oct. 8.
‘Tone Has Shifted’
While rising, 10-year yields remain below their average of 5.43 percent since 1990 even though the U.S. is running a budget deficit that exceeds $1 trillion, or more than 8 percent of the economy. The last time the U.S. had a surplus, from 1998 through 2001, yields averaged 5.45 percent.
“You’re not going to see a repeat of the low yields that we’ve seen in the last six months,” said Sean Simko, who oversees $8 billion as a managing director at SEI Investments Co. in Oaks, Pennsylvania. “The overall tone has shifted. The trend is higher in yield, but it won’t be in a straight line.”
Yields on 10-year notes will hold below 4 percent for a fourth consecutive year in 2011, according to the median estimate in a Bloomberg News survey of the primary dealers. Some of the optimism over the recovery was tempered Jan. 7 when the Labor Department in Washington said U.S. payrolls increased by 103,000 in December, below the median forecast of 150,000 in a Bloomberg News survey.
Dealers usually bet against Treasuries to hedge against the risk that changes in interest rates will erode the value of their corporate and mortgage-related debt. In the five years before Lehman Brothers Holdings Inc. collapsed in September 2008, dealers had an average $107 billion net short position, compared with an average $24.2 billion bet in favor of the debt since 2008, Fed data shows.
Wall Street’s holdings of Treasuries swelled to a 17-month high of $81.3 billion on Nov. 24 from $18.4 billion on Aug. 18, just before Bernanke gave a speech in Jackson Hole, Wyoming, that bolstered speculation the Fed would resume purchases of government debt to boost the economy and avoid deflation. The official announcement came Nov. 3.
Firms dumped Treasuries as reports pointed to sustained economic growth, said Amitabh Arora, an interest-rate strategist at primary dealer Citigroup Inc. in New York. “There was a lot of capitulation of bad positions,” he said.
While last week’s jobs report fell short of forecasts, other data from the government, Fed and private sector since December showing gains in manufacturing and industrial production have prompted economists to increase their estimates for gross domestic product.
New York-based JPMorgan Chase & Co., the second-biggest U.S. bank by assets, boosted its 2011 forecast by half a percentage point to 3.1 percent. A government report on Jan. 14 will show retail sales rose for a sixth month, economists said.
“We still have headwinds, but their strength has been somewhat offset by the increase in tailwinds,” said David Ader, head U.S. government bond strategist at CRT Capital Group LLC in Stamford, Connecticut. “Maybe we’ve reached a point of equilibrium.”
In the corporate debt market, investment-grade bond yields have shrunk to within 163 basis points, or 1.63 percentage points, of Treasuries, Bank of America Merrill Lynch index data show. Spreads were 181 basis points a year ago and 574 in 2009.
Corporates, Mortgages
Speculative-grade companies, those rated below Baa3 by Moody’s Investors Service and BBB- by Standard & Poor’s, can sell bonds at yield spreads averaging 523 basis points, down from 603 a year ago and 1,642 two years ago, based on Bank of America Merrill Lynch indexes.
Primary dealer holdings of corporate bonds due in more than one year totaled $85.7 billion on Dec. 29, up from last year’s low of $75.7 billion on Aug. 4. Mortgage securities totaled $58.8 billion, compared with $31.8 billion on March 10.
Gains in equities and the dollar also suggest rising confidence in the economy.
The Standard & Poor’s 500 Index rose 24 percent to 1,271.50 from last year’s low on July 2. IntercontinentalExchange Inc.’s Dollar Index, which tracks the greenback against the currencies of six major U.S. trading partners including the euro, yen and pound, advanced 2.51 percent to 81.012 last week, and has surged 7.1 percent from 2010’s low of 75.631 on Nov. 4.
Breakeven Rates
The outlook for inflation is also rising. The difference between yields on 10-year notes and Treasury Inflation-Protected Securities, a gauge of trader expectations for consumer prices, widened to 2.43 percentage points on Jan. 5, the most since April.
“If the market expects the economy to strengthen, investors ratchet back expectations for Fed purchases and reduce their bid for the assets, and rates rise,” Fed Governor Elizabeth Duke said in the text of a speech in Baltimore on Jan. 7. The recent rise in yields “is due to exactly this latter circumstance -- a strengthening in market participants’ outlook for the economy and a corresponding decrease in the market’s expectation for future accommodation,” she said.
To contact the reporter on this story: Daniel Kruger in New York at dkruger1@bloomberg.net
To contact the editor responsible for this story: Dave Liedtka at dliedtka@bloomberg.net
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