Investors Seek Bigger Gains in Europe: Government Bond Outlook
June 30 (Bloomberg) -- U.S. Treasury yields fell to the lowest in more than four decades during the first six months of the year as an anemic recovery in the world's largest economy bolstered demand for government debt.
The streak may be poised to end as some investors move money into European sovereign debt, such as German bunds, where they see potential for greater gains. Demand for Treasuries will falter as U.S. stocks rally, economic growth accelerates over the next six months, and the government sells a record amount of debt to finance a widening budget deficit, investors said.
``Most of the market is vulnerable,'' said Bill Gross, who heads Pacific Investment Management Co.'s Total Return Fund, the world's biggest bond fund. ``Treasuries and corporates are suckers' bets; the priority going forward should be to capture as much carry yield as possible,'' which is the difference between the yield investors earn and the cost of owning the security.
Newport, California-based PIMCO boosted holdings of foreign government debt last month to 11 percent of the funds' $76.1 billion in assets from 1 percent at the end of April. It lowered holdings of Treasuries and agency debt to 27 percent.
The yield on the benchmark 3 5/8 percent note maturing in May 2013 traded above 3.5 percent on Friday after touching a 45-year low of 3.07 percent June 16. German 10-year bunds have performed better than the most active 10-year Treasury note as the economy in the 12 nations sharing euro grew at a slower pace than the U.S.
The yield on the most actively traded 10-year bund has dropped more than 40 basis points to 3.85 percent in the past six months. The gap between the yields on the bund and 10-year Treasury note widened by 30 basis points, indicating investors are inclined to pay more to own German government debt. A basis point equals 0.01 percentage point.
Fed vs ECB
``The euro-zone has been a hot place'' for buying ``because the returns are very good,'' said Hiroki Itoh, who helps manage the equivalent of $1.5 billion at Cigna International Investment Advisors Co. in Tokyo. Itoh said he is considering buying U.S. or European debt for Cigna's $100 million global bond fund.
Gains for U.S. debt may be over as the Federal Reserve's benchmark interest rate is half the European Central Bank key rate of 2 percent, which was reduced by half a point on June 5 to the lowest since 1948. Policy makers representing the 12 nations sharing the euro said this week that rates were at a level to help the region's economy recover, indicating the ECB is in no hurry to cut rates again.
The Fed is expected to keep its target interest rate for overnight lending at a 45-year low after reducing it by a quarter point on Tuesday, in part to thwart the risk of slowing inflation hurting the economy's growth prospects, investors said. Further reductions are unlikely, they said.
`Spark a Revival'
``You have to think that you are near the lows in Treasury yields,'' said Kevin McKenna, who oversees $175 billion as head of fixed-income investment at New York-based Merrill Lynch Investment Management, a unit of Merrill Lynch & Co., the largest securities firm by capital.
Fed policy makers ``are going to spark a revival in aggregate demand, and when the market believes that mission is accomplished rates will start to move up in their own accord,'' he said. McKenna, who sees yields on the 10-year note rising to 3.75 percent by yearend, holds fewer Treasuries than recommended by the benchmark he follows, the Lehman Brothers Aggregate Bond Index.
ECB officials have accelerated their pace of rate reductions, cutting borrowing costs three times since December, totaling 1.25 percentage points. Since January 2001, the ECB has lowered its target by 2.75 percentage points, less than the 5.5 percentage points in cuts by the Fed during the same period. Japan's central bank lowered its key rate close to zero in February 2001 and has restored to buying government debt to increase cash in the banking system since then.
Asian Buyers
The decline in Treasuries may be limited as Asian buyers seek higher returns in U.S. and European debt because of the low rates in the region and as the Bank of Japan buys Treasuries with the proceeds of its yen sales, analysts said.
Japan's 10-year government bond gained in the past six months as the country saw little to no growth in the economy. The yield on Japan's benchmark 10-year bond declined almost a quarter point to 0.73 percent.
Cathay Life Insurance Co., Taiwan's largest life insurer, has boosted its purchases of U.S. and European debt to capitalize on yields more than double what it can earn at home.
``Allocation-wise, more than half of our overseas investments are in U.S.-dollar assets,'' said Lee Chang-ken, chief strategy officer at Taipei-based Cathay Financial Holding Co., parent of Cathay Life Insurance Co. Markets abroad ``give us more investment options.''
Deficit Hangover
Foreign holdings of U.S. government securities have risen for seven weeks, totaling a record $750.1 billion in the week ended June 18. The gains came as the Bank of Japan, attempting to stem gains in its currency and boost exports, sold a record 3.98 trillion yen ($33.3 billion) in May. The Bank of Japan refrained from selling the currency in April after selling 2.39 trillion yen in the first quarter.
Japan has the world's largest debt market and a budget deficit equal to about 140 percent of its gross domestic product. The government buys about 1.2 trillion yen of Japanese government bonds per month, helping keep yields of even 10-year notes near 0.5 percent.
Demand for Treasuries may be damped as the government sells more securities and increases the amount it borrows to refinance maturing debt to fund a swelling U.S. deficit. Congress has enacted three of President George W. Bush's tax-cut proposals totaling about $1.7 trillion since he took office in January 2001.
The Treasury will have to refinance $564 billion of government debt that matures in 2004, and debt sales may total $396 billion next year to fund the deficit alone, said Gemma Wright, director of research at Barclays Capital Inc. in New York.
`Nice Pickup'
Signs the U.S. economic recovery is accelerating will drive Treasury yields to 4.63 percent by September of next year, according to the Bond Market Association's mid-year survey of economists at 22 financial institutions. The economy may grow 3.5 percent in the second half and 3.6 percent in 2004, the survey showed.
Treasury Secretary John Snow said last week in a television interview with Bloomberg News in Washington the U.S. economy is poised for a `nice pickup.'' The former railroad executive said the nation's gross domestic product would grow at ``well over 3 percent'' in the last two quarters of the year.
By comparison, the economy of the 12 nations sharing the euro may not grow at all through the third quarter, the European Commission, the European Union's executive body, estimated. The ECB expects growth to be at best 1 percent this year.
``The European economic fundamentals are very bond supportive,'' said Adrian Owens, who helps run $5 billion in bonds as director of fixed-income at Julius Baer Investments Ltd. in London. ``I'm not in the camp that sees this as the beginning of the upturn in the U.S. and that growth will revive strongly. There's an election in the U.S. in November 2004. Is the Fed going to hike rates before then? No.''
Last Updated: June 30, 2003 00:04 EDT
Bloomberg
June 30 (Bloomberg) -- U.S. Treasury yields fell to the lowest in more than four decades during the first six months of the year as an anemic recovery in the world's largest economy bolstered demand for government debt.
The streak may be poised to end as some investors move money into European sovereign debt, such as German bunds, where they see potential for greater gains. Demand for Treasuries will falter as U.S. stocks rally, economic growth accelerates over the next six months, and the government sells a record amount of debt to finance a widening budget deficit, investors said.
``Most of the market is vulnerable,'' said Bill Gross, who heads Pacific Investment Management Co.'s Total Return Fund, the world's biggest bond fund. ``Treasuries and corporates are suckers' bets; the priority going forward should be to capture as much carry yield as possible,'' which is the difference between the yield investors earn and the cost of owning the security.
Newport, California-based PIMCO boosted holdings of foreign government debt last month to 11 percent of the funds' $76.1 billion in assets from 1 percent at the end of April. It lowered holdings of Treasuries and agency debt to 27 percent.
The yield on the benchmark 3 5/8 percent note maturing in May 2013 traded above 3.5 percent on Friday after touching a 45-year low of 3.07 percent June 16. German 10-year bunds have performed better than the most active 10-year Treasury note as the economy in the 12 nations sharing euro grew at a slower pace than the U.S.
The yield on the most actively traded 10-year bund has dropped more than 40 basis points to 3.85 percent in the past six months. The gap between the yields on the bund and 10-year Treasury note widened by 30 basis points, indicating investors are inclined to pay more to own German government debt. A basis point equals 0.01 percentage point.
Fed vs ECB
``The euro-zone has been a hot place'' for buying ``because the returns are very good,'' said Hiroki Itoh, who helps manage the equivalent of $1.5 billion at Cigna International Investment Advisors Co. in Tokyo. Itoh said he is considering buying U.S. or European debt for Cigna's $100 million global bond fund.
Gains for U.S. debt may be over as the Federal Reserve's benchmark interest rate is half the European Central Bank key rate of 2 percent, which was reduced by half a point on June 5 to the lowest since 1948. Policy makers representing the 12 nations sharing the euro said this week that rates were at a level to help the region's economy recover, indicating the ECB is in no hurry to cut rates again.
The Fed is expected to keep its target interest rate for overnight lending at a 45-year low after reducing it by a quarter point on Tuesday, in part to thwart the risk of slowing inflation hurting the economy's growth prospects, investors said. Further reductions are unlikely, they said.
`Spark a Revival'
``You have to think that you are near the lows in Treasury yields,'' said Kevin McKenna, who oversees $175 billion as head of fixed-income investment at New York-based Merrill Lynch Investment Management, a unit of Merrill Lynch & Co., the largest securities firm by capital.
Fed policy makers ``are going to spark a revival in aggregate demand, and when the market believes that mission is accomplished rates will start to move up in their own accord,'' he said. McKenna, who sees yields on the 10-year note rising to 3.75 percent by yearend, holds fewer Treasuries than recommended by the benchmark he follows, the Lehman Brothers Aggregate Bond Index.
ECB officials have accelerated their pace of rate reductions, cutting borrowing costs three times since December, totaling 1.25 percentage points. Since January 2001, the ECB has lowered its target by 2.75 percentage points, less than the 5.5 percentage points in cuts by the Fed during the same period. Japan's central bank lowered its key rate close to zero in February 2001 and has restored to buying government debt to increase cash in the banking system since then.
Asian Buyers
The decline in Treasuries may be limited as Asian buyers seek higher returns in U.S. and European debt because of the low rates in the region and as the Bank of Japan buys Treasuries with the proceeds of its yen sales, analysts said.
Japan's 10-year government bond gained in the past six months as the country saw little to no growth in the economy. The yield on Japan's benchmark 10-year bond declined almost a quarter point to 0.73 percent.
Cathay Life Insurance Co., Taiwan's largest life insurer, has boosted its purchases of U.S. and European debt to capitalize on yields more than double what it can earn at home.
``Allocation-wise, more than half of our overseas investments are in U.S.-dollar assets,'' said Lee Chang-ken, chief strategy officer at Taipei-based Cathay Financial Holding Co., parent of Cathay Life Insurance Co. Markets abroad ``give us more investment options.''
Deficit Hangover
Foreign holdings of U.S. government securities have risen for seven weeks, totaling a record $750.1 billion in the week ended June 18. The gains came as the Bank of Japan, attempting to stem gains in its currency and boost exports, sold a record 3.98 trillion yen ($33.3 billion) in May. The Bank of Japan refrained from selling the currency in April after selling 2.39 trillion yen in the first quarter.
Japan has the world's largest debt market and a budget deficit equal to about 140 percent of its gross domestic product. The government buys about 1.2 trillion yen of Japanese government bonds per month, helping keep yields of even 10-year notes near 0.5 percent.
Demand for Treasuries may be damped as the government sells more securities and increases the amount it borrows to refinance maturing debt to fund a swelling U.S. deficit. Congress has enacted three of President George W. Bush's tax-cut proposals totaling about $1.7 trillion since he took office in January 2001.
The Treasury will have to refinance $564 billion of government debt that matures in 2004, and debt sales may total $396 billion next year to fund the deficit alone, said Gemma Wright, director of research at Barclays Capital Inc. in New York.
`Nice Pickup'
Signs the U.S. economic recovery is accelerating will drive Treasury yields to 4.63 percent by September of next year, according to the Bond Market Association's mid-year survey of economists at 22 financial institutions. The economy may grow 3.5 percent in the second half and 3.6 percent in 2004, the survey showed.
Treasury Secretary John Snow said last week in a television interview with Bloomberg News in Washington the U.S. economy is poised for a `nice pickup.'' The former railroad executive said the nation's gross domestic product would grow at ``well over 3 percent'' in the last two quarters of the year.
By comparison, the economy of the 12 nations sharing the euro may not grow at all through the third quarter, the European Commission, the European Union's executive body, estimated. The ECB expects growth to be at best 1 percent this year.
``The European economic fundamentals are very bond supportive,'' said Adrian Owens, who helps run $5 billion in bonds as director of fixed-income at Julius Baer Investments Ltd. in London. ``I'm not in the camp that sees this as the beginning of the upturn in the U.S. and that growth will revive strongly. There's an election in the U.S. in November 2004. Is the Fed going to hike rates before then? No.''
Last Updated: June 30, 2003 00:04 EDT
Bloomberg
