I was unaware of the seasonal aspects to trading treasuries. This is interesting! So far there is no evidence that the summer rally in treasuries is waning, but I will keep this seasonal aspect in mind for future reference.
(Bloomberg) -- One of the best bets in the $6.45 trillion Treasury market may no longer be such a sure thing.
Yields on benchmark 10-year U.S. notes fell from June through September in 15 of the last 20 years by an average of 35 basis points as the U.S. wrapped up the bulk of its debt auctions and investors reinvested the proceeds from interest and coupon payments. The last time yields failed to decline was in 2005, when they rose 34 basis points as the Federal Reserve boosted interest rates.
Investors anticipating another “summer rally” may be disappointed as Treasury Secretary Timothy Geithner accelerates debt sales to finance a record budget deficit. After more than doubling note and bond offerings to $963 billion in the first half, another $1.1 trillion may be sold by year-end, according to Barclays Plc, one of the 16 primary dealers that are obligated to bid at Treasury auctions. The second-half sales would be more than the total amount of debt sold in all of 2008.
“I used to be a believer,” said Gary Pollack, who helps oversee $12 billion as head of fixed-income trading at Deutsche Bank AG’s Private Wealth Management unit in New York, and has worked in the bond market since 1978. “The amount of Treasury debt that needs to be financed is a game-changer. Normally the seasonals work because of the ebb and flow in terms of the Treasury’s needs. That is no longer the case.”
Favoring Company Debt
Pollack is reducing his Treasury holdings in favor of corporate bonds on the expectation the difference in yields between company and government debt will narrow, he said.
Investment-grade corporate debt yields 3.31 percentage points more than Treasuries, almost triple the average for the decade before the credit markets seized up in 2007, according to Merrill Lynch & Co. index data.
The seasonal rally Treasuries is akin to the stock market adage of “sell in May and go away,” where traders pared back on equities on the expectation that most of the gains come early in the year, said Thomas di Galoma, head of U.S. rates trading at Guggenheim Capital Markets LLC, a New-York based brokerage for institutional investors.
The absence of a rally this summer will be particularly troubling for investors, who have suffered the worst year on record for Treasuries. The securities lost 4.46 percent through June, according to Merrill Lynch & Co.’s U.S. Treasury Master index. The index rose 14 percent last year as the global economy lapsed into the worst recession since World War II.
Lost Year
Even if yields stayed constant for the remainder of the year, investors would still realize an annual loss for just the third time since Merrill Lynch started calculating returns in 1978. When Treasuries fell in 1994 and 1999, it was because the Fed raised interest rates.
The yield on the benchmark 10-year note fell four basis points, or 0.04 percentage point, last week to 3.50 percent, according to BGCantor Market Data.
Yields reached a high for the year of 4 percent on June 11, up from the record low of 2.04 percent on Dec. 18. They will end the third quarter little changed at 3.48 percent before rising to 3.63 percent at year-end, according to a Bloomberg News survey of 65 economists that gives the most recent forecasts given the heaviest weighting.
Money flows, such as the reinvestment of Treasury coupon payments every August, are typically responsible for the usual strong summer performance of bonds rather than diminished supply, said James Caron, head of U.S. interest-rate strategy in New York at primary dealer Morgan Stanley.
Treasury Payments
Investors will receive $30 billion in interest payments and $80 billion from maturing debt in August, according to the Treasury.
“There’s no reason to believe the pattern will not hold until it doesn’t,” Caron said. “It tracks the seasonality of the investment” into Treasuries, he said.
Caron said he expects 10-year yields to “grind lower” to the end of September, before rising to 4.25 percent at year end.
“I’m not so sure I would want to hang my hat on a seasonal pattern that has held true year after year after year, because the world has changed,” said Ray Remy, head of fixed income in New York at primary dealer Daiwa Securities America Inc. “I’m paying a lot less attention to it than I have in the past.”
Bond Auctions
The U.S. will conduct four auctions next week for the first time since the Treasury began issuing securities regularly in 1976. Today’s $8 billion auction of 10-year Treasury Inflation- Protected Securities will be followed by the sale $35 billion of 3-year notes tomorrow, $19 billion of 10-year notes the next day and $11 billion of 30-year bonds on July 9.
Demand has been rising at the sales, especially from the class of investors that includes foreign central banks.
Those investors, which the Treasury labels as “indirect bidders,” bought 67.2 percent of the record $27 billion in seven-year notes sold June 25, or double the amount at the prior sale in May. The ratio was also the highest since 2004 at the $37 billion auction of five-year notes the day before, while the $40 billion in two-year notes offered on June 23 attracted the most indirect bids in at least six years.
Demand for the 10- and 30-year debt may not be as strong given the gains in Treasuries after the 10-year yield reached 4 percent, said Michael Devlin, who trades the two securities for primary dealer Jefferies & Co. in New York. Each issue is also a so-called reopening of the securities originally sold in May.
‘Risks’ to Rally
“Given all the fundamental factors and supply this time around we are more careful when it comes to putting too much weight” on a rally, said Michiel de Bruin, who helps manage $27 billion as head of European government debt in Amsterdam at F&C Asset Management Plc’s Dutch unit. “This year the risks are that we will have a further economic recovery in the second half of the year, and together with supply it’s putting downward pressure on prices.”
President Barack Obama has pushed the nation’s marketable debt to an unprecedented $6.45 trillion from $5.75 trillion in January. The budget deficit is projected to quadruple to $1.85 trillion in the fiscal year ending Sept. 30, equivalent to 13 percent of the nation’s economy, according to the nonpartisan Congressional Budget Office. The U.S. sold a record $104 billion in 2-, 5- and 7-year notes two weeks ago.
The Treasury will sell $2.07 trillion in debt this year, with $1.53 trillion in net supply after redemptions, compared with $921 billion in auctions raising a net $373 billion last year, according to Michael Pond, an interest-rate strategist in New York at Barclays.
‘Different’ This Year
“This year may be a little bit different given the supply, the budget deficit and the Fed,” said Richard Schlanger, who helps invest $13 billion in fixed-income securities as vice president at Pioneer Investments in Boston. Seasonal patterns had factored into Schlanger’s trading “in the past” though it won’t this year, he said.
As part of a plan to keep borrowing costs low throughout the economy and absorb some Treasury issuance, the Fed has bought $190.7 billion of U.S. notes and bonds beginning March 25. The central bank said it would buy as much as $300 billion of the debt in its March 18 policy statement, and has declined to add to that commitment after its meetings in April and June.
“The Fed being done with its buying program may preclude a lot of portfolio managers from buying,” said Schlanger, who stopped buying Treasuries in May after the Fed declined to add to its purchases in April. “The bias still is for a steeper yield curve and longer-term Treasuries rising in yield.”
