[DEBATE] : (US) Treasuries lose appeal for Asian, European investors

[Riaz K Tayob]

Snip:

Treasury Secretary Henry Paulson's proposal, which seeks funds to rescue 
banks by purchasing devalued securities, would drive the country's debt 
to more than 70 percent of gross domestic product. The last time 
taxpayers owed as much was in 1954, when the U.S. was paying down costs 
from World War II.
...
"A big question mark hangs over whether the U.S. can deal with an 
unprecedented amount of debt. That is unnerving all the investors, 
including me."
...
The government depends on foreign money to finance the budget deficit, 
which UBS AG estimates will increase to $1 trillion next year from $407 
billion if the bailout is approved.
...

Treasuries lose appeal for Asian, European investors
    
Submitted by cpowell on 05:51PM ET Wednesday, September 24, 2008. 
Section: Daily Dispatches

By Daniel Kruger and Kyoungwha Kim
Bloomberg News
Wednesday, September 24, 200

http://www.bloomberg.com/apps/news?pid=newsarchive&sid=a.48CsrdmQvo

Investors outside the United States, who own more than half of all 
Treasuries outstanding, say the government's $700 billion plan to revive 
the banking system will diminish the appeal of the nation's bonds.

Treasury Secretary Henry Paulson's proposal, which seeks funds to rescue 
banks by purchasing devalued securities, would drive the country's debt 
to more than 70 percent of gross domestic product. The last time 
taxpayers owed as much was in 1954, when the U.S. was paying down costs 
from World War II.

"The image of U.S. Treasuries as a safe haven has been tainted by the 
ongoing financial debacle," said Kwag Dae Hwan, head of global 
investment in Seoul with South Korea's $220 billion National Pension 
Fund, which holds about $14 billion of U.S. government debt. "A big 
question mark hangs over whether the U.S. can deal with an unprecedented 
amount of debt. That is unnerving all the investors, including me."

The government depends on foreign money to finance the budget deficit, 
which UBS AG estimates will increase to $1 trillion next year from $407 
billion if the bailout is approved. Investors outside the U.S. own 56 
percent of the $4.8 trillion in marketable Treasuries outstanding, up 
from 42 percent of the $3.4 trillion outstanding five years ago, 
according to data compiled by the government.

... Keeping Rates Low

U.S. long-term interest rates would be 1 percentage point higher without 
demand from foreign governments and central banks, according to 
Professors Francis and Veronica Warnock at the University of Virginia in 
Charlottesville, who have done research for the Federal Reserve.

The benchmark 4 percent note due in August 2018 ended yesterday at 101 
21/32 to yield 3.80 percent, according to BGCantor Market Data. The 
yield fell to 3.78 percent as of 6:50 a.m. in New York today.

Demand for all but the safest of government debt increased in the past 
two weeks as the government seized control of Washington-based Fannie 
Mae and McLean, Virginia-based Freddie Mac, the country's biggest 
mortgage finance companies, and agreed to take over New York-based 
American International Group Inc., the largest insurer. The bankruptcy 
of Lehman Brothers Holdings Inc., also located in New York, on Sept. 15 
caused credit markets to seize up.

Yields on 10-year notes fell as low as 3.25 percent on Sept. 16 from the 
high this year of 4.27 percent on June 13. The rate on the three-month 
Treasury bill fell to as little as 0.02 percent on Sept. 18 as investors 
sought the safest securities.

... 'Unbelievably Expensive'

The drop in yields combined with the likelihood that the government will 
sell more debt makes Treasuries "unbelievably expensive," said Theodora 
Zemek, global head of fixed income at Axa Investment Managers in London, 
which has about 120 billion euros ($177 billion) invested in debt assets.

"There is little value other than panic value in government bonds," 
Zemek said. "We've potentially got a big sell-off."

While Treasuries of all maturities have returned an average of 4.2 
percent this year, including reinvested interest, Japanese investors 
lost money on U.S. debt, according to Merrill Lynch & Co. index data. A 
yen-based investor would have lost 0.4 percent as Japan's currency 
strengthened 5.9 percent against the dollar.

The U.S. may have to borrow an extra $700 billion to $1 trillion to fund 
the bailout, according to Barclays Capital Inc. interest-rate strategist 
Michael Pond in New York. The proposal, sent to Congress Sept. 20, would 
increase the nation's debt ceiling by 6.6 percent to $11.315 trillion.

... New Deal

Paulson and Federal Reserve Chairman Ben S. Bernanke made their case for 
the plan to Congress yesterday, pushing for the biggest federal 
intrusion into markets since the New Deal. The Fed and Treasury failed 
to stem the credit crisis sparked by the collapse of the subprime 
mortgage market by cutting its target interest rate for overnight loans 
between banks to 2 percent from 5.25 percent in September.

"If the credit markets are not functioning," Bernanke told the Senate 
Banking Committee yesterday in Washington, "the economy will just not be 
able to recover."

The cost to hedge against losses on 10-year Treasuries with 
credit-default swaps stood at 26.4 basis points, up from 2 basis points 
when the credit markets began to seize up in July 2007, according to BNP 
Paribas SA prices. That's higher than countries including Germany, Japan 
and France.

Credit-default swaps are financial instruments based on bonds and loans 
that are used to speculate on a borrower's creditworthiness. An increase 
indicates deterioration in the perception of credit quality. A basis 
point on a contract hedging $10 million of debt for five years is 
equivalent to $1,000 annually.

... Deteriorating Economy

Treasuries may appreciate as a slowing U.S. economy and inflation sparks 
demand for fixed-income, according to some investors. Growth may 
decelerate to 1.7 percent this year and 1.5 percent in 2009 from 2 
percent in 2007, according to the median estimate of 80 analysts 
surveyed by Bloomberg.

"Yields are driven by the economy, the financial system, and the 
inflation rate," said Robin Marshall, director of fixed-income in London 
at Smith & Williamson Investment Management in London, which oversees 
about $20 billion in assets. "I'm not sure supply will be the conclusive 
driver."'

Even with the economy slowing, the yield on the 10-year note has climbed 
from 3.25 percent on Sept. 16, which was the lowest since 2003, amid 
concern about increased debt supply and a widening budget deficit. The 
dollar has dropped 5.5 percent against the euro since reaching a 
one-year high on Sept. 11.

... Supply Concern

"Bond yields are reflecting supply concerns," said Felix Stephen, senior 
investment strategist in Sydney at Advance Asset Management Ltd., which 
oversees the equivalent of $6.56 billion. "The currency is also 
reflecting that, because global investors, predominantly the ones who 
will be buying this paper, want to make it as cheap as possible," 
Stephen said.

Stephen, whose International Fixed Interest bond fund returned 5.1 
percent this year, beating 83 percent of its peers, said he expects the 
10-year Treasury yield to rise to 4.75 percent in the second half of 
next year.

He may be right. Back in the 1950s, the last time debt as a percentage 
of GDP was as high as economists are now predicting, yields on long term 
government bonds rose to 4.27 percent from 2.32 percent, according to 
Sidney Homer's "A History of Interest Rates."