U.S. Treasuries: Yields Drop to Record Lows on Recession Concern

[Sapiens]

http://www.bloomberg.com/apps/news?p...d=asVyYZdqKEC4

Dec. 1 (Bloomberg) -- Treasuries rose, sending yields to record lows, before a report forecast to show U.S. manufacturing contracted in November at the fastest pace in 26 years.

The yield on two-year notes fell as low as 0.94 percent and on the 10-year to 2.84 percent as European and Asian stock losses stoked demand for the safest assets. Yields will decline in 2009 as the Federal Reserve lowers its 1 percent target rate for overnight loans between banks to zero, JPMorgan Chase & Co. wrote in a report on Nov. 28.

“It’s the economic outlook that’s moving the market,” said Lawrence Dyer, an interest-rate strategist in New York at HSBC Securities USA Inc., one of the 17 primary dealers that trade bonds with the Fed. The central bank will “make a commitment to keep rates low for a period of time, and that is a signal for the market to take two-year notes down to a zero carry against funding.”

The 10-year note yield fell eight basis points, or 0.08 percentage point, to 2.84 percent at 8:55 a.m. in New York, the least since Fed daily records started in 1962, according to BGCantor Market Data. It touched 2.78 percent in 1955 as measured on a monthly basis. The 3.75 percent security due November 2018 rose 24/32, or $7.50 per $1,000 face amount, to 107 26/32. The two-year note declined five basis points to 0.95 percent, after falling through 1 percent for the first time on Nov. 20.

The 30-year bond yield dropped 10 basis points to a record 3.33 percent.

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The difference between what banks and the Treasury pay to borrow money for three months, the so-called TED spread, widened to 218 basis points from 2008’s low of 76 basis points set in May. The spread was at 464 basis points on Oct. 10, the most since Bloomberg began compiling the data in 1984.

[Sapiens]

U.S. Treasuries: Unraveling the Mystery Behind High Prices

http://www.businessweek.com/print/in...130_509098.htm

Unraveling the Mystery Behind U.S. Treasury Prices
Recent trading in U.S. government debt has puzzled even seasoned pros. BusinessWeek looks into the Treasury market's stratospheric pricing

By David Bogoslaw

In a season characterized by an ever-growing list of unprecedented events—from repeated capital infusions by the federal government into U.S. financial institutions to historically high market volatility—it's tempting to shrug your shoulders when you come across truly puzzling valuations that appear to ignore economic fundamentals. Still, the extent to which investor demand for U.S. Treasury bonds has sent prices soaring and yields plummeting seems to defy reason.

To get a sense of how much demand there is for fully-guaranteed government bonds, just look at prices over the past few months. The benchmark 10-year Treasury note was trading at a price of 106-22/32 for a yield of 2.974% on Nov. 26; the price was 102-06/32, and the yield 3.73%, on Sept. 2.

Try as you might to justify these moves by citing the seemingly bottomless hunger for cash at American International Group (AIG), to the collapse of Lehman Brothers Holdings, to Citigroup's (C) precarious position, the activity in the Treasury market sparks a flurry of questions. Inexplicably, investors don't seem concerned about the low-to-no yields they are getting for their money.

Here are some of the Treasury market's greatest puzzles:

Puzzle No. 1: The upward march of Treasury prices

Bill Larkin, portfolio manager for fixed income at Cabot Money Management in Salem, Mass., thinks Treasury bonds are probably one of the most dangerous trades for investors right now. The stock and bond markets are pricing in the worst economy in 30 years, with no inflation expectations. "When you get into yields this low, and you get into this historic expensive zone, if you plan on holding them to maturity, you're fine. But in real terms, adjusted for inflation, you lose," he says.

Larkin says there's no doubt that the liquidity programs being enacted by the U.S. Treasury Dept. and the Federal Reserve will eventually stimulate growth and result in rising inflation, despite concerns about how effective these policies have been thus far in responding to the financial crisis.

Jim Sarni, managing principal at Payden & Rygel—an investment firm in Los Angeles that manages more than $50 billion in assets—calls the flight to quality into high-priced Treasury bonds a persistent disconnect between market fundamentals and market valuations on one hand, and people's desperation to avoid risk on the other. He notes how quick the Treasury has been to abandon certain strategies designed to spark lending and restore confidence in favor of new programs, without fully explaining to the public—or possibly even thinking through—how the proposed measures would actually work.

"As investors, we're all being bombarded by information that scratches the surface [in terms of trying] to solve the liquidity problems in the market," Sarni says. "Nothing is gaining traction because none of the details are known, and that's manifesting itself in people being skittish, which is driving them to the safest thing out there until there's more certainty about what's going on."

The latest announcement on Nov. 25 was that the Federal Reserve plans to buy up to $500 billion worth of mortgages bonds guaranteed by Fannie Mae, Freddie Mac, and Ginnie Mae, as well as an additional $100 billion of securities from mortgage finance companies such as the Federal Home Loan Bank. That caused interest rates on 30-year mortgages to drop three-quarters of a percentage point within one day, to around 5.5%. The news also helped drive a rally in prices on the 10-year Treasury note and it pushed the yield down to 3.094%, The Wall Street Journal reported the following day. On Nov. 26, the yield fell below 3.0%, the lowest it's been in more than 30 years.

Puzzle No. 2: Investors in Treasuries don't appear worried about inflation

Normally, the prospect of loads of new Treasury debt hitting the market—what the pros call "supply"—would engender nervousness about too much loose money triggering an uptick in inflation. But most investors aren't concerned about the liquidity that's been pumped into the financial system, which is occurring worldwide but is especially acute in the U.S. This is because they are primarily focused on the recession that's taken hold.

Foreign central banks have recently been the biggest buyers of Treasury bonds, says Jamie Jackson, fixed income portfolio manager at Riversource Investments (AMP) in Minneapolis. One reason for that demand is the central bankers' increasing reluctance to allocate their reserves to other high-quality bonds—such as those of Fannie Mae and other government agencies—since those agencies ended up in conservatorships in September, Jackson says. Those assets had become a major part of central banks' portfolios over the past decade.

Puzzle No. 3: International investors continue to buy high-priced Treasury bonds

The fact that demand for U.S. government notes from foreign central banks and other international investors hasn't diminished with yields so depressed can be bewildering. Such unattractive returns would normally cast a pall over the market, but demand has boomed in recent weeks. The saving grace has been a surge of strength in the U.S. dollar, whose value vs. the euro has risen by roughly 15% since late summer. Foreign investors holding dollar assets are often looking merely for appreciation in the currency as a reason to buy Treasury bonds, even if they're not getting much in terms of yield, says Tom DiGaloma, head of U.S. government bond trading at Jefferies & Co. (JEF) in New York. If they expect the dollar to keep appreciating in value, international investors see Treasuries as another way to make money, on the presumption that there will be plenty of buyers if they ever need to sell the bonds, he says. In that sense, their willingness to hold Treasury notes is a variation on the preoccupation with maximum liquidity displayed by domestic institutional investors.

And the dollar's strength is telling you there are probably much bigger problems outside the U.S., says DiGaloma. Foreign central banks still rely on the greenback as their reserve currency and in Europe, the prospect of economic contraction is more frightening. One in four jobs in London's economy is in the shrinking financial services sector, compared with a much smaller dependence by the American population, he says. "In European countries in general, that seems to be where a lot of financial engineering was taking hold. Banking was a bigger part of their economy than it is here," DiGaloma says.

Puzzle No. 4: Breakeven inflation rates for long-dated TIPS

Over the past six months, a shrinking number of asset classes have been meeting the basic investment threshold of retaining their principal value. It may not be a stretch to leave shorter-term inflation-indexed securities off that list, given growing fear that some deflation will already be evident by the time the shortest-term Treasury Inflation-Protected Securities, or TIPS, mature on Jan. 15, 2009, says Jackson of Riversource Investments.

That begs the question of how much of the current flight to principal preservation is rational, says Jackson. It's logical to assume breakeven inflation rates for TIPS with maturities out to one year, but "now it's getting to the point where even 10-year TIPS have negative breakeven inflation priced into them," he says incredulously. "We're in a recession. Maybe it's really deep, but is it enough to produce eight years of net deflation?"

That's the conclusion you come to when you subtract the real yield on inflation-protected bonds from the nominal yield on regular Treasury notes, which translates to a yield that's barely keeping up with inflation. Jackson says it's clearly an overreaction born of fear when inflation expectations that show up in research surveying everything from economists' views to consumer sentiment aren't even close to zero.

The debate between those warning about deflation caused by sharp economic contraction and those more concerned that ongoing liquidity injections will ignite inflation is far from settled. Some market strategists project a period of initial deflation that gives way to accelerated inflation by 2010.

Most of the demand for Treasuries has been in the short end of the yield curve, which is reflected in yields around 1% for the two-year note and 0.04% for the three-month note.

Puzzle No. 5: Safety vs. return

David Glocke, principal and portfolio manager at the Vanguard Group in Valley Forge, Pa., believes the exceptionally strong performance in Treasuries stems from more than just an elevated flight to quality. It appears that value-seeking investors—who typically would come in to buy other kinds of assets when prices have dropped substantially—are absent from the marketplace, especially in the stock market, he says. Glocke also has reason to believe that some of the demand for Treasuries is coming from the unwinding of certain hedged positions.

While institutional investors have little choice but to invest in Treasuries because they need maximum liquidity to manage their portfolios, retail investors who have far less need for liquidity would do better to look at higher yielding alternatives, says Cabot's Larkin. Rather than make the mistake of focusing on principal preservation at any cost, retail investors would be better off following the basic rule of investing, which is to buy low and sell high,

Sarni at Payden agrees that investors who aren't concerned about liquidity should be concentrating on investment fundamentals. "The challenge is they buy low and you know what happens? It goes lower," he says. "At some point, you say: 'To heck with it. Whether I need liquidity or not, I'm going to stick my head in the sand until things calm down.'"

Retail and institutional investors alike are just trying to preserve what they have, rather than worry about yields and returns, Sarni adds.

The rationale for sticking with more volatile assets, even as they get buffeted on especially grim news days, is that you don't want to miss the inevitable turnaround after the market puts in a bottom. From Sarni's perspective, however, nobody's worried about the market getting away from them if a sustained rally materializes. "If we miss the first 1%, 2%, 5%—or even 10%—who cares? The markets are down anywhere from 40% to 80%. If you miss 10% on the upside, there's still going to be a heck of a lot to go," he says.

Bogoslaw is a reporter for BusinessWeek's Investing channel.

Duh! In a debt money system Treasuries are Money! No mystery in that...

[Master Shake]

Re: U.S. Treasuries: Unraveling the Mystery Behind High Prices

I'm responsible for the recent sharp drop in long-term Treasuries. I bought some TBT two weeks ago. Never fails; I'm a perfect inverse barometer.