February 10, 2006
THE 30-YEAR QUESTION
We know why they're selling it. The question is, why are they buying it?
The "it" here is the 30-year Treasury bond, which returned to the capital markets after a four-and-a-half year respite. By all accounts, the security's return was a rousing success, at least for the government. Buyers were crawling over each other to grab a slice of government debt whose principal won't be returned until 2036. Bloomberg News reports that yesterday's bidding was such that the yield fell to 4.53%, the lowest on record for a 30-year Treasury.
The government could hardly wish for something better. Perhaps the feds could advise GM and Ford on how to better market their wares. Indeed, federal deficits may be mounting, but the public is only too happy to help Uncle Sam bridge the red-ink gap. Now that's what we call effective marketing.
In fact, the return of the 30-year Treasury is only the latest government triumph in managing its debt load. Readers may recall that the Treasury announced last April that it would stop paying variable rates on U.S. savings bonds and instead offer a fixed yield. Now, the Treasury has started selling 30-year bonds again. Who says the private sector has a lock on savvy traders?
All in all, the folks at Treasury are batting a thousand when it comes to strategic thinking on debt management. Financing the government's projected fiscal year deficit of $337 billion, or 2.6% of GDP at historically low rates for 30 years is nothing short of brilliant.
The clarity on the sell side gives way to a raging debate about the wisdom of the buy side. If the government deserves kudos for selling 30-year bonds at ~4.53%, how then should we label the action of the buyers?
Like everything else in fixed-income land, the answer depends on where you think rates are headed in the coming years. Clearly, those who think long rates are destined to rise are in the minority, to judge by yesterday's embrace of the 30 year as if it was a long lost uncle returning from the wilderness. No less a respected force of analytical thinking than BCA Research predicts that bond yields around the world are headed lower, mostly on the belief that economic growth will continue to slow. If true, buying a 30-year Treasury may prove to be a winning trade.
Nonetheless, over at that other institution in Washington, efforts are underway to keep short rates rising, arguably with an eye on raising long rates. This, one could say, represents a threat to the assumption that buying a 30-year bond at a 4.53% is a good deal. On the other hand, perhaps it's an aid, in that higher rates will eventually slow the economy. Even if we agree on what's coming, we can still argue about the effects.
Speaking of arguing, how should an informed investor assess the future of economic growth, interest rates and inflation with the news of a robust labor market of late? The two-week average of initial jobless claims through last week fell to its lowest since April 2001, notes David Resler, chief economist at Nomura Securities in New York, in a note to clients yesterday. "The downtrend in claims reveals a healthy job market that is likely to generate the sort of employment and income growth necessary to generate the growth in consumer spending necessary to sustain a 'virtuous cycle' of growth," he advises.
Still, there are no absolutes in fixed-income trading, although relative value springs eternal. On that note, here are some of the alternatives to the 30-year's 4.53%, as of yesterday's close:
10-year Treasury: 4.54%
2-year Treasury: 4.66%
10-year inflation-protected Treasury: 2.05%
5-year CD (national average): 4.47%
Inflation-protected savings bond: 6.73%
One could argue that locking in a yield of 4.53% for the next three decades makes sense if it satisfies one's liabilities. Pension funds tend to think in such terms, and so any instrument that dispatches liabilities to the dust bin of history in a timely manner is a step forward on the road to financial salvation.
But not everyone, whether institutional or individual, can reasonably hope that future financial burdens will advance at a relatively meager rate of 4.53%. The challenge gets worse after adjusting for inflation. Based on the latest measure of annualized consumer prices, and assuming that inflation is at least as high going forward, a nominal 4.53% yield on the 30-year Treasury evaporates into a real yield of around 1.1%, or about half the rate on the current real yield of a 10-year inflation-protected Treasury.
Some may have the brainpower to know what's coming. For the rest of us, hedging one's bets looks like a safer bet. Diversification has rarely looked so enticing.
Posted by jp at February 10, 2006 10:00 AM
convexity may be another reason to buy the 30y rather than, say, the 10y or strips.
Posted by: captain nemo at February 13, 2006 3:35 AM
There are eight million investment horizons in bond land. Ours is a medium- to long-term focus, which informs our thinking, enlightened and otherwise.
Posted by: Jim Picerno at February 11, 2006 7:01 AM
Hit The Bid hit it on the head. The 30-year has a lot of volatility which offers some great trading opportunities. The Fed has not been in contention for these dollars for almost 5 years.
Posted by: thc at February 10, 2006 10:21 PM
Also remember that buying the bond, regardless of level, and even relative value is an outstanding way to pick up duration in a portfolio--either for directional exposure or to reduce liability exposure.
Don't forget about the strips/zero market as well...these guys have been dry for years and the stri to recon ratios i'm sure are very favorable to buying them and selling off the parts.
In fixed income trading, the reasons for buying and selling often have nothing to do with the straight up yield(and barely anyone holds it to term).
Posted by: Hit The Bid at February 10, 2006 12:12 PM