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| The Fed holds $1.66 trillion of Treasuries, including $520 billion of debt due in 2014 and sooner. |
Wall Street’s biggest bond traders
are stockpiling Treasuries at the fastest pace since 2007 on
speculation the Federal Reserve will announce a plan this week
to buy longer-term debt to spur the faltering economy.
The 20 primary dealers held $15.1 billion of Treasury
securities due in more than one year as of Sept. 7, up from a
$75 billion bet against the debt on May 6, Fed data show. The
last time dealers bought bonds at such a rapid pace was between
July 2007 and September 2007, as losses on subprime mortgages
began to infect credit markets and the central bank unexpectedly
cut interest rates.
All but one firm expects the central bank to announce some
type of what traders call Operation Twist, according to a
Bloomberg News survey, the latest step by the Fed in its four-
year effort to keep the economy out of a recession. U.S. debt
due in 10 years or more has returned 17 percent this quarter,
the most since the last three months of 2008, as unemployment
holds above 9 percent and growth slows.
“The problems are endless” for the economy, William O’Donnell, the head U.S. government bond strategist in Stamford,
Connecticut at RBS Securities Inc., a primary dealer, said in a
Sept. 13 telephone interview. “What will surprise people is how
long this period lasts of very, very low rates.”
Falling Yields
Treasury 10-year note yields fell to a record 1.877 percent
on Sept. 12, down from this year’s high of 3.77 percent on Feb.
9. The yield dropped six basis points to 1.99 percent at 10:29
a.m. in London, according to Bloomberg Bond Trader prices. The
benchmark 2.125 percent note due in August 2021 rose 17/32, or
$5.31 per $1,000 face amount, to 101 7/32.
Yields fell as evidence mounted that the economy wasn’t
responding after the Fed, led by Chairman Ben S. Bernanke, cut
its target interest rate for overnight loans between banks to
almost zero and purchased $2.3 trillion of bonds from November
2008 through June to drive down market borrowing costs.
The Organization for Economic Cooperation and Development
cut its forecast for U.S. gross domestic product on Sept. 8 to
1.1 percent this quarter and 0.4 percent in the fourth. That’s
down from the prior estimate of 2.9 percent and 3 percent.
“The market is pricing in a reasonable probability of the
Fed not being able to stimulate growth in any meaningful way,”
Shyam Rajan, an interest-rate strategist in New York at Bank of
America Corp., a primary dealer, said in a Sept. 12 telephone
interview. “On the margin every step helps. But is this a cure-
all for the economy, doing Operation Twist? No.”
Chubby Checker
Operation Twist gets its name from a policy conducted by
the Fed in cooperation with the Treasury Department in 1961,
when the central bank bought long-term securities as the
government concentrated its issuance in shorter maturity debt.
While Fed staff called it Operation Nudge, it became known
as Operation Twist, after Chubby Checker’s hit, The Twist,
according to a report published March 14 by Eric Swanson, an
economist at the Federal Reserve Bank of San Francisco. The move
lowered long-term Treasury yields by about 15 basis points, or
0.15 percentage point, according to Swanson.
Policy makers meet the next two days, after Bernanke said
in an address at the Kansas City Fed’s annual monetary policy
conference Aug. 26 that the Fed still had “a range of tools
that could be used to provide additional monetary stimulus.”
Fed Minutes
Minutes of the Fed’s Aug. 9 meeting released Aug. 30 showed
that some central bankers said selling debt with shorter
maturities and purchasing longer-term securities had the
potential to push borrowing costs lower.
The Fed holds $1.66 trillion of Treasuries, including $520
billion of debt due in 2014 and sooner that could be sold and
reinvested in securities maturing from 2018 to 2039, according
to CRT Capital Group LLC strategists David Ader and Ian Lyngen.
That may pull 10-year yields down to 1.6 percent, they said.
Economists and strategists at Credit Suisse Group AG,
another primary dealer, said in a Sept. 16 report that the Fed
will likely announce that it’s buying $400 billion of Treasuries
with maturities of seven to 10 years over the next six months.
Any signs that Europe is moving closer to resolving its
debt crisis may keep bonds from rallying. Yields may rise to 2.5
percent for 10-year notes and to 3.75 for 30-year bonds by year-
end if officials from the 17 nations that share the euro are
able to insulate the region’s banks from Greece, Ireland and
Portugal, said Amitabh Arora, an interest-rate strategist in New
York at Citigroup Global Markets, another primary dealer.
German 10-year bunds yielded 1.79 percent, compared with
22.56 percent for similar-maturity Greek securities.
‘Priced In’
The effect of an Operation Twist is “pretty much priced
in,” Arora said in a Sept. 13 telephone interview. “What’s not
priced in is a change in outlook for growth. As long as the
European crisis does not end up a core banking crisis, we’re
going to end up higher with yields by the end of the year.”
Cantor Fitzgerald LP is the only dealer surveyed by
Bloomberg News to say it doesn’t expect the Fed to announce an
Operation Twist-like policy.
“There’s a concern about the marginal impact of operations
like this,” Brian Edmonds, the head of interest rates at Cantor
in New York, said in a Sept. 16 telephone interview. “We have a
low-rate environment. Will another 20 basis points in 10-year
notes make a big difference? It might seem like not a great time
for the Fed to try something where there might not marginally be
a big difference in what they do.”
‘Reserve Creation’
At least one dealer said there’s a chance that the Fed may
go beyond Operation Twist and print more cash to buy $600
billion to $1 trillion of Treasuries if policy makers determine
the economy may be heading toward another recession.
“To beat around the bush at this point doesn’t make any
sense,” George Goncalves, the head of interest-rate strategy in
New York at Nomura Holdings Inc., said in a Sept. 14 telephone
interview. “If things are that bad and require easing, I think
it’s more effective to go to reserve creation instead of trying
to change the composition of the portfolio, which might not
necessarily work.”
By focusing on lowering long-term bond yields, policy
makers are trying to support demand for homes and cars, as well
as for corporate debt, as lawmakers reign in expenditures.
The extra yield investors demand to own U.S. high-grade
bonds rather than government debt has widened 12 basis points to
233 basis points this month through Sept. 15, compared with an
expansion of 31 basis points to 290 for debentures in Europe,
Bank of America Merrill Lynch index data show.
The debt limit extension signed by President Barack Obama
on Aug. 2 requires $2.4 trillion in spending cuts over the next
10 years. The economy didn’t add any jobs in August, and the
unemployment rate held at 9.1 percent, the Labor Department said
Sept. 2.
‘Played Out’
The ability of monetary policy to boost the economy “is
largely played out at this stage,” Michael Cloherty, head of
U.S. interest rate strategy at New York RBC Capital Markets,
said in a telephone interview Sept. 13. RBC is a primary dealer.
Since the signs of stress in the financial system first
began in June 2007, there have been four instances where bond
dealers increased holdings of Treasury notes and bonds.
The first and fastest move was from July 2007 through
September 2007, when dealers added $98.8 billion as two hedge
funds run by Bear Stearns Cos. began to collapse and Paris-based
BNP Paribas SA halted withdrawals from three of its funds
because the bank couldn’t “fairly” value their holdings.
The Fed addressed that crisis by cutting the discount rate
it charges banks for short-term funds by 50 basis points to 5.75
percent in August 2007, followed the next month by reducing the
federal funds rate by the same amount to 4.75 percent.
Third Time
Dealers added $103.8 billion from November 2008 to April
2009, as the Fed began to buy $600 billion of mortgage and
related debt. That program was expanded in March 2009 to total
$1.25 trillion of mortgages, $300 billion of Treasuries and $200
billion of agency debentures.
The third time came when they increased holdings of U.S.
government notes and bonds by $47.5 billion from September 2010
through November 2010, amid rising speculation that the Fed
would resume buying Treasuries as growth slowed.
“Certainly, something’s coming from the Fed,” Suvrat Prakash, an interest-rate strategist in New York at BNP, another
primary dealer, said in a Sept. 12 telephone interview.
Primary Dealer Year-End Yield Forecasts and Operation Twist Firm 10-Year 30-Year Twist? Bank of America 2.3 3.7 Yes Barclays 2.25 3.55 Yes BNP Paribas 2.5 3.55 Yes Cantor Fitzgerald 2.375 3.75 No Citigroup 2.35 3.65 In November Credit Suisse 1.75 3.35 Yes Daiwa 2.25 3.75 In December Deutsche Bank 2.25 3.5 Yes Goldman Sachs 2.75 3.75 Yes HSBC 2.4 3.6 NA Jefferies 2 3.25 Yes JPMorgan Chase 2.6 3.9 Yes MF Global 2.8 4 Yes Mizuho 1.5 NA In November Morgan Stanley 2.1 3.5 Yes Nomura 2.3 3.6 Yes RBC 2.1 3.5 Yes RBS 1.75 2.85 Yes Societe Generale 2 NA Yes UBS 2.5 NA Yes Mean 2.24 3.57
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