Treasury Yield Rise Slowed as Currency Reserves Grow

Treasury Yield Rise Slowed as Currency Reserves Grow (Update3)

Share Business ExchangeTwitterFacebook| Email | Print | A A A

By Daniel Kruger and Matthew Brown

April 6 (Bloomberg) -- The fastest growth in global currency reserves since the credit crisis is blunting a rise in Treasury yields even as concern increases about record U.S. borrowing to finance an unprecedented budget deficit.

Worldwide reserve assets climbed 18 percent to $7.8 trillion in the 12 months ended in March, the biggest increase since the collapse of Bear Stearns Cos. in March 2008, according to data compiled by Bloomberg. Bank of America Corp. and Royal Bank of Scotland Group Plc forecast that growth in reserves, led by Asian nations, will sustain demand as Greece’s fiscal woes raise concern about the risk of holding sovereign debt and corporate bonds offer the slimmest yield premiums over Treasuries since November 2007.

The Obama administration is counting on foreign investors, who own half of the outstanding $7.4 trillion in marketable Treasury debt, to continue buying while the Federal Reserve begins a shift in monetary policy. Former Fed Chairman Alan Greenspan and Pacific Investment Management Co.’s Bill Gross have said that yields will rise, lifting borrowing costs and reducing demand for Treasuries, as the U.S. borrows record amounts to support an economy emerging from the worst contraction since the 1930s.

“If you go into Treasuries you’ll be winning because of the rising dollar, even if yields rise,” said Christoph Kind, head of asset allocation at Frankfurt Trust in Frankfurt, which manages about $20 billion. “There was a lot of speculation about Asia diversifying away from the dollar, but I think there is a bit of frustration from what happened to the euro after the Greek crisis.”

Dollar Market Share

The U.S. dollar’s share of global currency reserves rose to 62.1 percent in the fourth quarter of 2009 while the euro’s share dropped to 27.4 percent, the International Monetary Fund said March 31 in a quarterly report. The two-year Treasury yield rose 0.19 percentage point to 1.14 percent and the dollar advanced 2.2 percent to $1.4321 per euro during the period.

Interest-rate futures traded at the CME Group exchange show that expectations for an increase in the central bank rate by November have risen to 71 percent from 62 percent a month ago. Of the 18 primary dealers that serve as counterparties to the Fed in open market operations, 10 are forecasting an increase in the central bank’s target rate by the end of the year.

International Reserves

Global reserves rose 10 percent to $8.09 trillion in 2009, IMF data show. Bank of America and RBS Securities forecast worldwide reserve growth to lead to increased demand for U.S. assets including Treasuries as investors seek markets where securities are most easily traded.

“A lot depends on what China does, but based on what we’ve seen so far I think you have to think reserves are going to grow something on the order of 5 to 10 percent globally,” said Robert Sinche, chief strategist at Lily Pond Capital Management LLC in New York.

History suggests foreign investors including China, the largest U.S. creditor, will be buyers as the narrowing advantage in yield on investment-grade corporate debt or mortgage-backed securities makes Treasuries more attractive. China’s largest increases in purchases have come during the month where the 10- year Treasury yield peaked in three of the last four years.

Yields on 10-year notes, the benchmark for everything from mortgages to corporate bonds, reached 4 percent yesterday for the first time since June. At the same time, data last month showed that foreign holders added Treasuries for a ninth consecutive month as the global economy recovered. The U.S. will sell $2.43 trillion of notes and bonds this year, according to 10 primary dealers in a Bloomberg News survey.

Currency Manipulation

A portion of China’s Treasury purchases have been made in order to maintain the linkage of the value of its currency, the yuan, with the dollar. China tightened the relationship in July 2008 as the financial crisis worsened after allowing the yuan to float within a band in July 2005.

Treasury Secretary Timothy F. Geithner said April 3 that the U.S. would delay a report on global currency policies scheduled for April 15, and urged China to move toward a more flexible currency. The decision came days after Chinese President Hu Jintao announced plans to visit Washington for a nuclear summit April 12-13.

Geithner faces demands from Congress to label China a currency manipulator for keeping the value of the yuan little changed from about 6.83 to the dollar for almost two years.

‘Huge Overhang’

Bond dealers forecast the yield on the 10-year note will climb to 4.2 percent at the end of this year, according to the median estimate in a survey by Bloomberg News. That’s still lower than the 5.46 percent average over the last 20 years. The yield declined 4 basis points to 3.95 percent at 10:36 a.m. in New York, according to BGCantor Market Data.

“Bonds have seen their best days,” Bill Gross, manager of the world’s biggest bond fund at Pacific Investment Management Co., said in a March 25 interview with Tom Keene on Bloomberg Radio from Pimco’s headquarters in Newport Beach, California.

Higher yields are the “canary in the mine,” Greenspan said in a March 26 interview on Bloomberg Television’s “Political Capital With Al Hunt.” The increases reflect concern over “this huge overhang of federal debt which we have never seen before,” he said.

Yield Spread

The difference in yield between Treasuries and investment grade corporate bonds has narrowed to 1.59 percentage points, the lowest since November 2007, from a high of 6.56 percentage points in November 2008, according to Bank of America Merrill Lynch index data. Mortgage spreads have narrowed from 1.92 percentage points in December 2008 to a yield 0.02 percentage point below Treasuries in November as the Fed ended its $300 billion program of Treasury purchases while continuing its $1.25 trillion operation to buy mortgage securities. The buyback of mortgages was completed last week.

China bought $114.3 billion of Treasuries in June 2009, the month the 10-year Treasury yield touched 4 percent; $69.8 billion in June 2007, when the yield hit a five-year high of 5.32 percent; and $47.8 billion in June 2008 as the yield reached 5.25 percent.

“They are buying when the market is weak,” said Michael Cheah, who manages $2 billion in bonds at SunAmerica Asset Management in Jersey City, New Jersey, and is a former official at Singapore’s central bank.

China may widen the yuan’s trading band against the dollar in the second quarter to as much as 2 percent, up from 0.5 percent, allowing the currency to resume appreciation to help curb inflation, according to UBS AG.

Geithner on China

The U.S. strategy is “designed to increase the odds that China does decide to do what’s in their interest, which is to let their currency start to move up again, and that’ll be part of making sure we have a more healthy global recovery in place,” Geithner said during an April 2 interview with Bloomberg Television in New York.

Treasury purchases may continue should China allow its currency to appreciate because “when the private sector realizes that Asian currencies will be allowed to appreciate capital flows might increase,” said Stephen Jen, managing director of macro and currencies, BlueGold Capital Management LLP in London. “It’s not clear whether reserve accumulation will be more or less with more currency movement. Asian central banks will still need to be major purchasers of U.S. assets in the order of what we’ve seen in recent years.”

‘Out the Curve’

China increased its holdings of notes and bonds in January while letting a portion of its record bill holdings acquired during the financial crisis mature. Notes and bonds owned by China rose 0.8 percent to $831.4 billion, while bill holdings dropped 17 percent to $57.6 billion, according to the latest Treasury Department data.

Japan, Switzerland, India and Canada have also been buying Treasury notes and bonds even as their positions in Treasury bills maturing in a year or less have declined. Foreign investors’ holdings of bills reached a peak at $607.3 billion in August and have since declined 16 percent to $508.5 billion, Treasury data show.

Foreign investors in Treasuries are taking increasing amounts of interest-rate risk on the debt rather than seeking out higher yields with corporate bonds as some concerns remain that U.S. policy makers led by President Barack Obama and Federal Chairman Ben S. Bernanke have not cleared the final hurdles in efforts to stabilize the economy, said Priya Misra, head of U.S. rates strategy at Bank of America in New York.

“You’ve seen the healing of the credit markets, issuance has come back in credit,” Misra said. “We all would have all expected them to move into spread product. Instead it’s moved out the Treasury curve.”

To contact the reporters on this story: Daniel Kruger in New York at [e-mail]; Matthew Brown in London at [e-mail]