The Problem With Obamanomics: Treasury TIPS Sale Draws Negative Yield for First Time (Wait For It...)
October 25th, 2010
The Treasury sold $10 billion of five-year Treasury Inflation Protected Securities at a negative yield for the first time at a U.S. debt auction as investors bet the Federal Reserve will be successful in sparking inflation.
The securities drew a yield of negative 0.55 percent, the same as the average forecast in a Bloomberg News survey of 7 of the Fed’s 18 primary dealers. The sale was a reopening of an $11 billion offering in April. Conventional Treasury notes erased gains amid speculation on the amount of debt the Fed may buy to spur the economy in a tactic called quantitative easing.
“It signals people’s expectation of the Fed being able to create some inflation with the QE program,” said Alex Li, an interest-rate strategist in New York at Deutsche Bank AG, which as a primary dealer is required to bid at Treasury auctions. “With nominal rates so low, in order have high TIPS breakevens you’ve got to have negative real yields on the five-year.”
Holders of TIPS receive an adjustment to the principal value of their securities equal to the change in the consumer price index, in addition to a fixed rate of interest that’s smaller than the interest paid to a holder of conventional debt. The difference between is known as the breakeven rate.
The fixed payment on five-year TIPS, known as the real yield, has been pushed below zero because the rise in the CPI is greater than the yield on regular five-year U.S. notes, which has fallen with other Treasury yields as investors sought the safety of U.S. government debt. A negative yield suggests investors are betting Fed Chairman Ben S. Bernanke will be successful in preventing deflation and the risk of the economy slipping back into recession.
‘Good for the Economy’
The U.S. can only sell TIPS at a negative yield, according to McKayla Barden, a spokeswoman at the Bureau of the Public Debt. It’s not government policy to auction conventional debt at that level, she said.
The negative yield is “a reflection of where the overall rate environment is, combined with the expectation for the Fed to stoke inflation and get prices rising again, which will ultimately be good for the economy,” said Ian Lyngen, a government bond strategist at CRT Capital Group LLC in Stamford, Connecticut. “It does demonstrate faith in the Fed and the Fed’s ability to spur inflation, which is their desire.”
Inflation in 2010 will be 1.6 percent, according to the median estimate of 59 forecasters in a Bloomberg News survey.
Thirty-year bond yields declined two basis points to 3.91 percent at 4:57 p.m. in New York, after earlier dropping as much as seven basis points to 3.86 percent, according to BGCantor Market Data. Ten-year note yields rose one basis point to 2.56 percent, after earlier falling to 2.49 percent.
‘Run Up and Down’
“There is a lot of thought going into trying to figure out what the Fed is going to do,” said Martin Mitchell, head government bond trader at the Baltimore unit of Stifel Nicolaus & Co., a St. Louis-based brokerage firm. “The differing views minute to minute are causing Treasuries to run up and down, with most people preferring to sit on their hands until the news is handed down.”
Bernanke said at conference Oct. 15 the economy may need more stimulus because inflation is too low and unemployment too high at 9.6 percent. Core prices, which exclude food and fuel, were little changed in September, capping a 0.8 percent increase in the past 12 months, the smallest year-over-year gain since 1961. The Fed next meets Nov. 2-3.
New York Fed Bank President William Dudley repeated his view today that the central bank will probably need to stage a second round of unconventional stimulus to combat too-low inflation and too-high unemployment. Dudley, vice chairman of the Federal Open Market Committee, spoke in Ithaca, New York.
Sustained Price Declines
While central banks are typically more concerned about faster inflation, the worst financial crisis since the Great Depression has made sustained price declines a bigger concern. Fed policy makers, who already cut interest rates almost to zero and bought $1.7 trillion of securities, are discussing more purchases of Treasuries to flood markets with cheap money to prevent stagnating prices from undermining the recovery.
“With more quantitative easing the likelihood of a deflation scare over the short term has decreased significantly, as the Fed is committed to upping inflation expectations,” said Keith Blackwell, an interest-rate strategist at Royal Bank of Canada in New York, a primary dealer. “TIPS look much more attractive.”
At today’s auction, the bid-to-cover ratio, which gauges demand by comparing total bids with the amount of securities offered, was 2.84, versus 3.15 at the April offering and an average of 2.38 at the past 10. Indirect bidders, a class of investors that includes foreign central banks, purchased 39.4 percent of the notes today. At the April sale, they bought 23.1 percent, the lowest in the history of the securities.
The last five-year TIPS auction, on April 26, drew a yield of 0.55 percent, which was then the lowest on record.
The dollar dropped to a 15-year low versus the yen after a pledge by the Group of 20 nations Oct. 23 to avoid “competitive devaluation” failed to dispel speculation the Fed will debase the greenback by announcing more bond purchases in a strategy called quantitative easing.
The Fed may begin its bond purchases with $500 billion over six months, according to a report from Goldman Sachs Group Inc. economists led by Jan Hatzius in New York. The company, a primary dealer, said policy makers will announce the plan after their November meeting. Ultimately the central bank may buy $2 trillion of assets, the note said.
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