Friday, May 22, 2009

There’s a lack of confidence in dollar assets and the bond market is repricing itself

TO BE NOTED: From Bloomberg:

"U.S. 10-Year Note Falls Most Since June on Supply, Credit

By Susanne Walker

May 22 (Bloomberg) -- Treasuries fell, pushing 10-year notes to their biggest weekly loss since June 2008, as investors prepared for the U.S. government to resume debt sales after a two-week hiatus.

Ten-year yields rose above 3.4 percent for the first time since November amid concern the record supply of Treasuries to pay for a mounting budget deficit may jeopardize the U.S.’s AAA credit rating. Longer-maturity notes and bonds led the declines, sending yields on 10-year securities to 2.56 percentage points above those on two-year notes, the most since November.

“We are testing key levels on the long end of the market,” said Hicham Hajhamou, a trader in New York at BNP Paribas, one of the 16 primary dealers that trade with the Federal Reserve. “There’s a lack of confidence in dollar assets and the bond market is repricing itself.”

The yield on the 10-year note rose nine basis points, or 0.09 percentage point, to 3.45 percent at 2:15 p.m. in New York, according to BGCantor Market Data. The price of the 3.125 percent security due in May 2019 fell 3/4, or $7.50 per $1,000 face amount, to 97 1/4.

The yield has surged 32 basis points this week, the most since gaining 35 basis points to 4.26 percent in the period ended June 13 on concern about inflation.

Yields on 10-year notes touched the highest level since Nov. 19 after Standard & Poor’s cut its outlook on the U.K.’s AAA credit rating yesterday and Pacific Investment Management Co.’s co-chief investment officer, Bill Gross, said the U.S. will “eventually” lose its top rating.

$6.36 Trillion

President Barack Obama has pushed the nation’s marketable debt to an unprecedented $6.36 trillion. His administration raised on May 11 its estimate for the deficit this year to a record $1.84 trillion, up 5 percent from the February estimate, and equal to about 13 percent of the nation’s GDP.

“It’s not an issue of whether the rating changes now,” Mohamed El-Erian, Pimco’s chief executive officer, said in a CNBC interview today. “It’s whether the markets start pricing in some change.”

White House Press Secretary Robert Gibbs said Obama isn’t concerned about “a change in our credit rating.” Asked if he expects a change, Gibbs said, “I don’t believe they will be cut.” Gibbs was responding to questions at his regular briefing.

The U.S. will issue a record $3.25 trillion of debt in fiscal year ending Sept. 30, according to Goldman Sachs Group Inc., another primary dealer.

U.S. Dollar Weakness

The Treasury announced this week it will auction $40 billion in two-year notes on May 26, $35 billion in five-year notes on May 27 and $26 billion in seven-year notes on May 28. The Treasury also sell $61 billion in three-month and six-month bills weekly auction on May 26.

“We are at a point where the supply considerations are overwhelming to the dealer community,” said David Ader, head of U.S. government bond strategy at Greenwich, Connecticut-based RBS Greenwich Capital, in an interview on Bloomberg Radio. “The world is having a hard time digesting all this supply.”

After gaining 14 percent in 2008 as investors sought a refuge from mounting losses on securities tied to subprime mortgages, Treasuries have lost 3.86 percent since December, according to Merrill Lynch & Co.’s U.S. Treasury Master index. German bunds have lost 0.8 percent, according to Merrill data.

Weakness in the U.S. dollar has made U.S. assets less attractive to foreign investors. The Dollar Index, used by the ICE to track the U.S. currency versus the euro, yen, pound, Swiss franc, Canadian dollar and Swedish krona, has fallen 11 percent from its high this year of 89.624 on March 4.

Credit Default Swaps

“The urgency for money managers with large U.S. dollar holdings to diversify could well intensify,” analysts led by Callum Henderson, global head of currency strategy in Singapore at Standard Chartered Bank, wrote in a research note today.

Central bank data indicates continued foreign demand for U.S. assets. The Fed’s custodial holdings of Treasuries for foreign accounts including central banks rose to a record $1.89 trillion, according to the Fed. Foreign holders added $26.7 billion of Treasuries for the week ended May 20, the largest increase since December.

The cost to hedge against losses on U.S. government bonds for five years climbed to a three-week high, indicating perceptions the nation’s credit quality is deteriorating. Credit-default swaps on U.S. debt rose 3.5 basis points to 41, the highest since April 29, according to prices from CMA Datavision in New York. An investor would have to pay $41,000 a year to protect $10 million of debt from default.

Credit-default swaps, contracts to protect against or speculate on default, pay the buyer face value if a borrower fails to adhere to its debt agreements.

Fed Purchases

Treasury yields rose even as the Fed bought $18.277 billion of U.S. debt in three purchase operations this week and minutes of the central bank’s April 28-29 policy meeting showed some officials judged the policy makers may need to boost asset purchases to secure a stronger economic recovery, while all agreed to hold off on such a move.

Ten-year yields have increased 92 basis points since March 18, when the Fed announced it would buy up to $300 billion in U.S. debt over six months in an effort to lower consumer borrowing costs.

“The Fed may have to announce a change in quantitative easing to help support the market,” said Thomas Tucci, head of U.S. government bond trading in New York at RBC Capital Markets, the investment-banking arm of Canada’s biggest lender. “The Fed will have to have an alternative or expansion to the current quantitative easing policy to help support the market.”

The central bank has bought $122.984 billion in government securities through the program. The Fed’s next purchase is scheduled for May 26, when it will buy Treasury Inflation Protected Securities maturing between January 2010 and April 2032, followed by a purchase of debt maturing between May 2012 and August 2013 on May 27.

To contact the reporter on this story: Susanne Walker in New York at swalker33@bloomberg.net.

Last Updated: May 22, 2009 14:34 EDT

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