Almost Time for the Great Long Bond "Crash of 2008" - 14 May 2008?
Asia Biggest Bear on Treasuries as Yields Boost Bunds
By Wes Goodman and Kyoungwha Kim
June 23 (Bloomberg) -- Asian investors, who own 28 percent of U.S. government debt, are becoming bigger bears on the bond market now that inflation shows no signs of decelerating and the Federal Reserve isn't prepared to raise interest rates. (This is just the annual bond massacre and means little until and unless the US dollar joins in the decline - Jesse)
South Korea's pension service said U.S. yields are ``too low'' after accounting for inflation. Mizuho Asset Management Co., part of Japan's second-biggest bank, favors euro-denominated debt and plans to purchase more. Kokusai Asset Management Co., which runs the world's second-largest managed bond fund, owns a record amount of European fixed-income securities.
``Europe has held out quite well, avoiding rate cuts, while the U.S. was bold in slashing borrowing costs,'' said Kwag Dae Hwan, head of global investments at the National Pension Service in Seoul, which holds about $14 billion of Treasuries. ``That puts Europe in a better position to cope with inflation now.''
Consumer prices will rise 3.8 percent this year in the U.S., versus 2.8 percent in the euro region, according to the median estimate of economists surveyed by Bloomberg News. U.S. 10-year notes yield about the same as the inflation rate, compared with an average of 2.03 percentage points more over the past decade. Investors can get more protection in Germany, where 10-year bunds yield 1.52 percentage points more than inflation.
Worst Since '80
The bear market in Treasuries that pushed yields on 10-year notes to 4.27 percent on June 13, the highest since December, was interrupted last week as traders pared bets the Fed would raise rates by September. Ten-year yields fell 9 basis points to 4.16 percent as the price of the 3.875 percent security due in May 2018 rose 3/4, or $7.50 per $1,000 face amount, to 97 21/32. The yield on Europe's benchmark 10-year note fell 1 basis point to 4.62 percent.
The U.S. 10-year yield fell 1 basis point today as of 1:14 p.m. in Tokyo. The European rate was unchanged.
Foreign investors, who hold almost half of the U.S.'s $4.69 trillion in marketable debt, are important because their purchases help finance the federal budget deficit, which is approaching the 2004 record of $413 billion. The deficit in May was $165.9 billion, bigger than the shortfall for all of fiscal 2007, according to the government.
If demand were to erode, it might drive down debt prices, adding to a slump that has put the U.S. bond market on the brink of its worst quarter in a generation. Treasuries have fallen 3.1 percent since March, their poorest showing since losing 5.06 percent in the third quarter of 1980, according to Merrill Lynch & Co.'s U.S. Treasury Master Index.
Confidence in Trichet
German bunds due in 10 years yield 48 basis points, or 0.48 percentage point, more than Treasuries of similar maturity. That's up from 17 basis points on May 13, and compares with the high this year of 56 basis points on Jan. 22.
Purchases of European debt by Asian investors, who hold more than $1.3 trillion in U.S. government bonds, are a vote of confidence in European Central Bank President Jean-Claude Trichet, who has kept the continent's benchmark rate at a six-year high of 4 percent as Ben S. Bernanke slashed the Fed's target to 2 percent from 5.25 percent in September.
Bernanke ``panicked'' as financial-market losses spread, said Allan Meltzer, the 80-year-old Carnegie Mellon University professor who has written a history of the Fed. Former U.K. Chancellor of the Exchequer Nigel Lawson, 76, said Bernanke may be ``regretting'' the cuts as global inflation accelerates.
Fed policy makers meet June 24-25, and will probably keep the target rate for overnight loans at 2 percent, according to all 87 economists surveyed by Bloomberg News.
`Inflation Fighter'
Ten-year European yields will decline to about 3.9 percent by year-end, said Hiromasa Nakamura, a senior fund manager in Tokyo at Mizuho Asset, which oversees the equivalent of $36.9 billion as part of Mizuho Financial Group Inc. An investor who bought today would earn 8.1 percent should the forecast prove accurate, according to data compiled by Bloomberg.
The 10-year Treasury yield will fall to 4 percent, according to a Bloomberg survey of economists, with the most recent forecasts given the heaviest weightings. Investors would earn only 3.5 percent in that case.
``The ECB is an inflation fighter,'' said Nakamura. ``It may raise interest rates next month. The economy will slow down because interest rates are still high.''
Japanese mutual fund holdings of euro-denominated bonds overtook assets in Treasuries in January, according to the Investment Trusts Association Japan. Euro debt holdings rose 2.5 percent in the year through April to 5.96 trillion yen ($55 billion), as dollar bonds fell 18 percent to 5.41 trillion yen.
China Boosts
Treasuries are benefiting as central banks in Asia invest record currency reserves in global bonds after the dollar ``bottomed,'' said John Rothfield, senior currency strategist at Banc of America Securities LLC in San Francisco, a unit of the second-biggest U.S. bank. The dollar has gained 1.2 percent against the euro this quarter, after a 7.6 percent slump in the first three months.
China increased its Treasury holdings by $11.4 billion in April to an all-time high of $502 billion, part of its investment of $1.68 trillion of reserves, the largest in the world.
The support these purchases provide to the dollar ``is not guaranteed in the months ahead'' because the funds may be reallocated to higher-yielding assets, Rothfield wrote in a report June 16. ``Flows in the U.S. identified as originating from the private sector remain very soft.''
Japanese investors cut their holdings of U.S. debt to $592.2 billion in April from a record $699.4 billion in 2004, Treasury Department figures show. They remain the biggest foreign owners.
Betting on Euro
Kokusai Global Sovereign Open, the second-biggest managed bond fund after Bill Gross's $128.8 billion Total Return Fund, reduced its U.S. holdings to a record low of 20 percent in March, compared with 44 percent in euros. It's buying the debt to take advantage of gains in the euro as well as a rally in bonds.
``We don't see a rate hike in the U.S., but the market has priced one in, temporarily helping the dollar,'' said Masataka Horii, one of four investors for the $51.8 billion fund in Tokyo. ``When traders unwind their positions, the euro will go higher against the U.S. currency.''
Investing in Europe
The ECB will raise its main refinancing rate once before starting to cut in 2009, said Mitsuo Masuda, a manager in Tokyo at the foreign bond section of Sumitomo Life Insurance Co. The firm is Japan's third-largest life insurer, with 3 trillion yen of non-yen bonds.
``We are positive on euro bonds,'' he said. Ten-year German yields will decline to below 4 percent by year-end, he said.
Shin Kong Life Insurance Co. in Taipei, Taiwan's third- largest insurer, holds just $1 billion of U.S. bonds among its $42 billion of assets.
``We don't have a clear outlook for the future in the U.S.,'' said Stan Lee, project manager in the investment relations division at Shin Kong Life. ``Inflation in Europe is not as serious so we have been investing there.''
To contact the reporter on this story: Wes Goodman in Singapore at wgoodman@bloomberg.net.
Last Updated: June 23, 2008 00:30 EDT
