as investors demanded higher yields to lend to the government for longer periods

TO BE NOTED: From Bloomberg:

"Treasuries Little Changed as Fed Readies Purchases of Debt

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By Dakin Campbell and Wes Goodman

April 13 (Bloomberg) -- Treasuries were little changed as the Federal Reserve prepared to buy U.S. government securities today and tomorrow in an effort to cut borrowing costs.

Investors seeking safety during the first global recession since World War II increased holdings of Treasury and agency debt to record levels, a survey of fund managers by Ried, Thunberg & Co. shows. Government and central bank reports this week will show U.S. retail sales rose in March, while a drop in factory production and slower inflation indicate the recession isn’t over, according to surveys of economists by Bloomberg.

“We traded off under the weight of supply last week,” said Martin Mitchell, head of government bond trading at the Baltimore unit of Stifel Nicolaus & Co. “Absent supply, the market will tend to drift lower in yield.”

The yield on the 10-year note rose one basis point to 2.93 percent as of 8:15 a.m. in New York, according to BGCantor Market Data. The price of the 2.75 percent security due February 2019 fell 1/32, or $0.31 per $1,000 face amount, to 98 14/32. U.K. trading of Treasuries was closed today for the Easter holiday, the Securities Industry and Financial Markets Association said.

Fed Buying

Ten-year yields will be in a range of 2.5 percent to 3 percent through the middle of the year, according to Kei Katayama, who oversees $1.6 billion of non-yen debt in Tokyo as leader of the foreign fixed-income group at Daiwa SB Investments Ltd., part of Japan’s second-biggest investment bank. The figure will fall to 2.75 percent by June 30, according to a Bloomberg survey of banks and securities companies with the most recent forecasts given the heaviest weightings. The yield has averaged 4.24 percent for the past five years.

The central bank plans to buy Treasuries due from March 2011 to April 2012 today and from September 2013 to February 2016 tomorrow, according to its Web site. The Fed has more than doubled the size of its balance sheet to $2.09 trillion in the past year by purchasing financial assets including Treasuries in an effort to spur growth.

Investors increased Treasury and agency holdings to 45 percent of their portfolios, matching the all-time high set in October 2002, according to Ried Thunberg, a research company in Jersey City, New Jersey. Agency debt is comprised mostly of securities sold by Fannie Mae and Freddie Mac, the two largest providers of funds for mortgages.

Decline Predicted

U.S. bonds may still fall, the survey showed. An index measuring investors’ outlook for Treasuries through the end of June declined to 43 for the seven days ended April 9 from 44 in the previous week. A reading below 50 means investors expect prices to drop. Ried Thunberg surveyed 25 fund managers controlling $1.35 trillion.

China, the largest holder of U.S. debt outside the nation, should buy more short-maturity U.S. Treasuries than long-term notes, the Oriental Morning Post reported today, citing a former adviser to the People’s Bank of China.

The government should “adjust the maturity structure, and keep asset and currency structures basically unchanged,” Li Yang said in Beijing, the Chinese-language newspaper reported.

Foreign holdings of Treasury bills surged to a record $486.9 billion in January from $207.1 billion a year earlier, according to the Treasury Department. Shorter-maturity bills tend to follow central bank interest rates while bonds are influenced more by inflation.

Yield Curve

The difference between two- and 10-year yields widened to 1.96 percentage points from 1.25 percentage points in December as investors demanded higher yields to lend to the government for longer periods.

Fed purchases have created a Treasury market “bubble” that may keep growing, said Jim Rogers, an investor and author of the book “Hot Commodities.” The Fed, like the Bank of Japan before it, is supporting government debt, he said.

“In Japan, long-term bonds were yielding one half of one percent at one time,” Rogers said on Bloomberg Television in an interview from Singapore, where he lives. “This can go to absurd levels, and bubbles usually do.”

Japan’s 10-year yields, little changed today at 1.46 percent, fell to 0.43 percent in June 2003, the lowest since Bloomberg data tracking the figure began in 1985.

Thirty-year mortgage rates rose to 4.87 percent in the seven days ended April 9 from 4.78 percent the week before, which was the lowest since Freddie Mac, the McLean, Virginia- based mortgage-finance company, began tracking the figure 37 years ago. Rates are 1.97 percentage points more than U.S. 10- year yields, widening from 1.46 percentage points two years ago.

TED Spread

Yields suggest U.S. credit markets haven’t fully recovered after last year’s decline.

The difference between what banks and the Treasury pay to borrow money for three months, the so-called TED spread, narrowed to 95 basis points from 96 basis points on April 10. The spread, which reached 4.64 percentage points in October, was about 36 basis points 24 months ago.

U.S. retail sales rose 0.3 percent in March, according to the median estimate in a Bloomberg News survey before the Commerce Department’s report tomorrow. Industrial production dropped 0.9 percent, the 14th decline in the last 15 months, figures from the Fed on April 15 may show, according to a separate Bloomberg survey.

The Treasury Department has ordered General Motors Corp. to prepare for a bankruptcy filing by June 1, the New York Times reported, raising speculation it will default on its bonds. The report cited people with knowledge of the plans.

Cost of Living

Treasuries fell last week as the government sold $59 billion of notes to help fund President Barack Obama’s spending plans. Government securities dropped 1.2 percent in April, extending a 1.4 percent loss in the first quarter that marked the worst start to a year since 1999, according to Merrill Lynch & Co.’s U.S. Treasury Master Index.

Fed Chairman Ben S. Bernanke’s efforts to spur growth may result in a higher cost of living, said Allan Meltzer, the central bank historian and professor of political economy at Carnegie Mellon University in Pittsburgh.

Inflation “will get higher than it was in the 1970s,” Meltzer said. At the end of that decade, consumer prices rose at a year-over-year rate of 13.3 percent. Rising costs erode the value of the fixed payments from bonds.

The difference between rates on 10-year notes and Treasury Inflation Protected Securities, which reflects the outlook among traders for consumer prices, was little changed at 1.35 percentage points from near zero at the end of 2008. The average for the past five years is 2.25 percentage points.

The U.S. consumer price index probably fell 0.1 percent in March from a year earlier, according to economists surveyed by Bloomberg before the Labor Department report on April 15. In February, the index rose at a year-over-year rate of 0.2 percent."

"“You still have a massive paranoia in the marketplace and you’ve got that safety-at-any-cost mentality,”

You can see the following behavior as sensible or over the top. From Bloomberg:

"By Matthew Benjamin and Liz Capo McCormick

Dec. 15 (Bloomberg) -- Bill Clinton was forced to abandon spending initiatives to boost the economy at the start of his presidency when advisers warned him that the borrowing needed to fund the programs would push interest rates higher. President- elect Barack Obama may not have the same problem.

While the total amount of U.S. government debt outstanding rose to $10.7 trillion in November from $9.15 trillion a year earlier, the amount of interest paid in the last two months fell by $10 billion, according to the Treasury Department.

Instead of shunning the U.S., where losses on subprime mortgages in 2007 triggered a global seizure in credit markets that led to the downfall of securities firms Bear Stearns Cos. and Lehman Brothers Holdings Inc., investors can’t get enough Treasuries. Even as estimates of Obama’s stimulus package and the budget deficit rise to a record $1 trillion, demand continues to increase as investors flee risky assets around the world and put their cash into U.S. bonds paying, in some cases, nothing in yield just to ensure the return of their principal.

“You still have a massive paranoia in the marketplace and you’ve got that safety-at-any-cost mentality,” said Jay Mueller, who manages about $3 billion of bonds at Wells Fargo Capital Management in Milwaukee. “People are not buying Treasury bills because they think the yields are attractive. They are buying them because they are afraid to put money anywhere else.”

This Fear and Aversion To Risk and the accompanying Flight To Safety are not driven but fundamentals and clear analysis. Could these investments prove sensible? Of course they could, but the Flight To Safety appears overdone.

Why to the US?

"Foreign central banks and other institutions are accumulating Treasuries at the fastest pace since 1988, boosting their holdings 12 percent since September, compared with a 7.7 percent increase last quarter, according to the Federal Reserve.

Purchases accelerated even as the yield on the benchmark two-year Treasury note tumbled to 0.76 percent last week from this year’s peak of 3.11 percent on June 13. Rates on three- month bills turned negative on Dec. 9 for the first time. The same day, the U.S. sold $30 billion of four-week bills at a zero percent rate. Yields on two-, 10- and 30-year Treasuries last week all fell to lowest since the U.S. began regular sales of those securities.

The two-year note yielded 0.73 percent as of 2:32 p.m. in New York, according to BGCantor Market Data, after falling as low as 0.66 percent on Dec. 12.

The drop in yields drove bond prices higher, pushing returns to 12.4 percent on average this year, the best performance since they gained 13.4 percent in 2000, according to New York-based Merrill Lynch & Co.’s U.S. Treasury Master Index. The returns compare with a drop of 41 percent in the Standard & Poor’s 500 Index and average losses of 15 percent in Merrill Lynch’s broadest corporate bond index."

If you had purchased bonds with higher yields, then you would be doing quite well now, which is why William Gross wishes that he had done so.

“This is not about return and yield and value; investors are functioning out of raw fear,” said Barr Segal, a managing director at Los Angeles-based TCW Group Inc., which oversees $90 billion in fixed-income assets. At the same time, “this is fabulous for the Treasury because they are borrowing at virtually nothing,” he said.

Japan’s bond market suggests that low yields may remain for a sustained period. In an effort to revive sagging growth in the 1990s, the world’s second largest economy ran its national debt to 1.5 times of gross domestic product. Yields on Japanese bonds are near the lowest in three years, with the country’s benchmark 10-year bond paying 1.40 percent, compared with 2.59 percent in the U.S. The national debt in the U.S. is 72 percent of GDP.

“It’s good news,” said James Horney, director of federal fiscal policy at the Center on Budget and Policy Priorities in Washington. “Even though we’re borrowing larger amounts of money, the total amount we’re going to pay in interest is going to be somewhat lower.”

Why aren't the people who claim that buying Toxic Assets during this crisis and Spending Money On Infrastructure now because wages and other costs are lower, recommending that we borrow freely now for no interest?

"Interest was $92.5 billion from August through November 2007 on the $9.15 trillion in total debt outstanding, resulting in interest expense of 1.01 percent. In the same period a year later, interest was $87.5 billion on $10.66 trillion in total debt, dropping the expense to 0.8 percent.

While the median estimate of 49 economists and strategists is for 10-year Treasury yields to end 2009 at 3.65 percent, that’s still below the average of 6.91 percent paid on the securities since 1962. The security helps determine corporate and consumer borrowing rates.

Obama plans an economic stimulus package that may approach $1 trillion, in addition to a middle-class tax cut and universal health care, which may add $4 trillion or more to the national debt over 10 years, according to the Tax Policy Center in Washington and health-care economists."

So we will borrow for less?

"The U.S. already posted a record $401.6 billion budget shortfall for the first two months of fiscal 2009, which began Oct. 1, according to a Treasury report last week. The largest postwar budget deficit by the U.S. was $412.7 billion in 2004.

“The role of the deepening economic slump in this deterioration coupled with the escalating size of the likely fiscal stimulus puts the deficit on course to exceed $1 trillion,” Edward McKelvey, a senior economist in New York at Goldman Sachs Group Inc., wrote in a Dec. 8 report to clients. “This implies upside risk to our $2 trillion figure for Treasury supply.”

Clinton’s proposals to spur the economy early in his administration in 1993 were stymied by concern how bond investors would react, according to James Carville, a Clinton consultant during the 1992 presidential campaign.

“Early in the Clinton days, the hallmark of policy was if you did this, how would it affect the bond market,” Carville said in an interview last year. “Every time I would talk to someone they would say ‘you can’t do that, it will freak the bond market out.’ I said ‘goddamn, whoever the bond market is, these bastards are powerful.’”

The potential for massive deficits has done nothing to damp demand for government debt as the U.S. prepares to spend $8.5 trillion to bailout financial institutions, homeowners and the economy. The biggest deficit as a percentage of the economy was 6 percent in 1983. A trillion-dollar 2009 gap would top that.

To prevent yields from rising, Fed policy makers indicated that the central bank may buy Treasuries. Fed Chairman Ben S. Bernanke suggested in a Dec. 1 speech that he would consider such a measure, saying one option is to buy “longer-term Treasury or agency securities on the open market in substantial quantities.”

“If there is a whiff of anything getting worse, the Fed can just go downstairs and start that printing press,” said Kevin Gaynor, head of economics and interest-rate strategy at Royal Bank of Scotland Group Plc in London. “They can easily stop targeting the federal funds rate and start targeting a two- or five-year Treasury yield.”

Policy makers may also cut interest rates again, which may keep bond yields low. The Federal Open Market Committee will reduce its target rate for overnight loans between banks by a half-percentage point, to a record 0.50 percent, when it meets Dec. 15-16, according to the majority of economists surveyed by Bloomberg News.

The U.S. economy has been in a recession for a year, the National Bureau of Economic Research declared on Dec 1. The economy will continue to contract through June, with unemployment rising above 8 percent the end of 2009, from 6.7 percent last month and this year’s low of 4.8 percent in February, according to Bloomberg surveys of economists. That would make the current slump the longest since the Great Depression.

“In some ways it’s ironic,” said Meg Browne, senior currency strategist at Brown Brothers Harriman & Co. in New York. “The U.S. turned down first and the crisis appeared first in the U.S., yet people continue to flock to the U.S. government debt market because it’s the biggest and deepest market in the world and still has a low risk.”

The U.S. will eventually have to commit to balanced budgets, said Alice Rivlin, former Fed vice chairman and founding director of the Congressional Budget office.

“We can’t press our luck,” said Rivlin, now a scholar at the Brookings Institution in Washington. “Eventually, we’ve got to show the world that we are fiscally responsible.”

This post went far and wide, then wider, but the points about printing money and showing that eventually we're going to handle this debt and deficit are correct points to be made.

"Foreign demand for any US bond with a smidgen of credit risk has disappeared."

Brad Setser with a continuing theme, the flight from risk:

"This is an example of what Calculated Risk calls cliff-diving. Foreign demand for any US bond with a smidgen of credit risk has disappeared. Indeed, the fall in demand for Agencies over the past three months is more severe than the fall in demand for US corporate bonds (think securitized subprime mortgages and other securitized housing and consumer debt) last August.

Normally, this kind of fall-off in foreign demand would be associated not just with a credit crisis but also with a currency crisis. A country cannot finance a trade and current account deficit without financing, and two big sources of financing for the US deficit — foreign purchases of Agencies and US corporate bonds — has disappeared. The US, though, isn’t a normal country. The fall in demand for risky US assets was offset by a rise in demand for Treasuries and the sale of foreign assets by Americans."

1)Trade & Current Account Deficit needs FINANCING
2) FINANCING from Foreign Purchases of AGENCIES & US CORPORATE BONDS
3) Without FINANCING = Credit & Currency Crisis
4) FINANCING ( now ) from Foreign Purchases of TREASURIES & FOREIGN ASSETS

"This data clearly shows a massive shift from Treasuries to Agencies.

To complete the picture I added short-term t-bill purchases by private investors to the long-term purchases and short-term official purchases. Total Treasury purchases over the last 3 months totaled $214 billion. That’s huge."

I think it's from AGENCIES to TREASURIES:

"Combining that inflow with $92 billion in net sales of foreign assets by American investors implies that the “flight to Treasuries” and “deleveraging” combined to provide about $300 billion in net financing to the US. That, in broad terms, allowed the US to run a roughly $175-200b current account deficit and cover a huge outflow from the Agency market.

China is particularly interesting case. SAFE clearly has added to the instability in the credit market over the past few months — and equally clearly contributed to low Treasury yields. That isn’t a criticism — it is just a statement of fact."

Low TREASURY Yields from high demand:

"At the end of July, China stopped buying Agencies and corporate bonds and started to pile into Treasuries. Over the last three months of data (i.e. the third quarter), the US data indicates that China has bought $81.1 billion in Treasuries ($45 billion short-term) and added $17.4 billion to its bank accounts — that is a flow of nearly $100 billion into the safest US assets China can find. Conversely, China sold $16 billion of Agencies, $1.8 billion of corporate bonds and a bit less than a billion of equity."

See this post.

"The September data also should put to rest all the talk about China retreating from Treasuries. The real issue is that China has retreated from the Agency market. True, September is a long time ago — but the Fed’s custodial data doesn’t suggest anything has changed since then.*

I’ll conclude by looking at trends over a somewhat longer time horizon. Starting last August, foreign demand for most kinds of risky US assets dipped. There is a clear break in a chart showing rolling 12m purchases of corporate bonds and equities back then. More recently, Agencies got reclassified as a risk asset. There was a bit of a fall off in demand for Agencies last August — but the really big fall off has come recently.

So the flight from risk started in August. Right now foreigners don’t seem to be interested in any kind of risky US asset.

Instead they are buying Treasuries.

And remember this is just a chart showing foreign purchases of long-term Treasuries. In addition to buying roughly $385 billion in long-term Treasuries, foreign investors snapped up another $240 billion (gulp) in short-term Treasuries. That works out to a net inflow in the Treasury market of over $600 billion …

Of course, Treasuries aren’t entirely risk free. I don’t believe that there is a real risk the Treasury would default. Buying credit-default swap protection on the US is something by colleague Paul Swartz calls an end-of-the-world trade. But foreign investors holding long-term Treasuries are clearly taking a lot of currency risk — especially if they are buying in now, after the dollar has rallied …

The US is taking a risk too. The rising stock of short-term bills held abroad does potentially leave the US more exposed to a rollover crisis."

They're buying now when the DOLLAR IS HIGH.

I'll say this again. I can understand the flight from risk.

NB: This Post:

"The plunging euro

Why is the euro plunging against the dollar and the yen? Why are European banks coming under renewed pressure? Should the emerging financial and foreign exchange crisis of countries gravitating around the euro lead to new EU policy instruments?

The euro is plunging against the dollar because investors, in their scramble for safety and liquidity, are flocking to US and, also to some extent, Japanese government bonds which are considered safer and more liquid than other government-backed paper available in the market – including public debt instruments issued by European governments. In other words, the constellation of separate markets for sovereign debt paper of unequal quality issued by European governments cannot compete with the US market for the huge global financial flows in search of a safe harbour."

And this post:

Saturday, October 25, 2008

``Any sense of rationality and fundamentals is thrown out the window.''

Bloomberg on the flight to safety, with the emphasis on flight:

"Dollar Gains Most Since 1992 on Concern Global Slump Deepening

By Ye Xie

Oct. 25 (Bloomberg) -- The dollar gained the most in 16 years against the currencies of six major U.S. trading partners as a global economic slowdown spurred demand for the greenback as a haven from losses in emerging markets.

``The foreign-exchange market is basically saying we are in a global recession and perhaps a very, very deep one,'' Richard Franulovich, a senior currency strategist at Westpac Banking Corp. in New York, said in an interview on Bloomberg Radio. ``Any sense of rationality and fundamentals is thrown out the window.''

I'm going to start collecting quotes saying that fundamentals are being ignored, as well as quotes showing that investors consider government intervention.

And this post:

Saturday, October 25, 2008

" Investors around the world fled stocks and rushed to the relative safety of the U.S. dollar"

The effects of the crisis are spreading. See this post in the Washington Post:

"Gloom about economic growth translated to low expectations for oil consumption. The Organization of the Petroleum Exporting Countries yesterday announced a cut of 1.5 million barrels a day in output -- a move that still failed to arrest the slide in crude prices. Meanwhile, copper prices fell to a three-year low.

Investors around the world fled stocks and rushed to the relative safety of the U.S. dollar by pouring money into 30-year Treasury bonds, a refuge in times of uncertainty. That drove down the value of foreign currencies, from the ruble to the rupee and the zloty to the peso, forcing central banks to spend billions of dollars to prevent even further deterioration. The turmoil in currency markets threatened to reorder trade relations and complicate recovery efforts."