The Fed votes for the bond market party to go on
The Federal Reserve on Tuesday committed to pumping more money into U.S. Treasury bonds, joining the horde of investors worldwide who continue to snap up Uncle Sam’s debt.
After their midsummer meeting, Fed policymakers said they would begin buying Treasuries with cash they get from maturing mortgage-backed bonds in their $2-trillion securities portfolio.
The move, a resumption of the bond-buying binge the Fed launched in 2009, is a way for the central bank to try to put more downward pressure on longer-term interest rates in general -- thereby, the Fed hopes, bolstering the economy. Yields on corporate, municipal and other bonds take their cue in part from Treasury yields.
The bond market’s reaction was gleeful -- like people at a party welcoming fun-loving new arrivals: The yield on the 10-year Treasury note (charted below), a benchmark for mortgage rates, slid to a 16-month low of 2.77% from 2.82% on Monday. It had already dived from 3.3% in mid-June.
The Fed’s New York branch later laid out the specifics of the program. The Fed said it would “concentrate” purchases of Treasuries in the two- to 10-year maturity range.
It isn’t clear how much new money the Fed will have to put into Treasuries each month. That will depend on how quickly the central bank’s $1.3 trillion in mortgage securities are paid off, which in turn will depend on the pace of home-loan refinancings and home sales.
But analysts estimate that the Fed will have between $10 billion and $30 billion a month from mortgage-bond payoffs to use for Treasury purchases. Guy Lebas, chief fixed-income strategist at brokerage Janney Montgomery Scott, estimated that the number could be about $25 billion a month, or $75 billion per quarter.
By contrast, the government’s net new borrowing to finance the budget deficit has been running at a rate in excess of $340 billion a quarter. The Treasury said last week that it expected to borrow a net $350 billion in the current quarter.This week alone the Treasury is selling a total of $74 billion in three-, 10- and 30-year securities. The three-year T-note sale, wrapped up earlier Tuesday, raised $34 billion at a yield of 0.84%.
The Fed’s expected new purchases may look incremental compared with the government’s overall borrowing, but they have to be viewed in the context of the ongoing huge demand for Treasuries from real investors.
Safety-seeking U.S. investors have been ramping up their purchases of government bonds in recent months. So have the Japanese. And now that the Fed has resumed buying, many investors may assume that this is just the opening round, with even larger purchases by the central bank down the road if the economy continues to weaken.
As the chart shows, potential bond buyers who’ve been waiting for a back-up in yields -- so they can jump in -- have been accommodated from time to time over the last few months. But the back-ups haven’t lasted for very long before yields have fallen again.
At what point will investors decide that Treasury rates are too low to be attractive? If you believe that deflation is a serious risk, then even at 2.77% the real (after inflation) return on a 10-year T-note would be generous.
But remember: Fed Chairman Ben S. Bernanke clearly is committed to making sure deflation doesn’t happen. If he succeeds, someday investors will again worry more about inflation than deflation -- at which point 2.77% may not look so appealing.
As the Japanese experience has shown, however, when a deflation mind-set takes over bond yields can plumb amazing depths. That’s still a key driving force in the Treasury market.
-- Tom Petruno