By Daniel Kruger
April 26 (Bloomberg) -- The bond vigilantes who punished governments for profligate spending in past years have gone into hiding.
Sovereign bonds yield an average 2.385 percent, about the same as a year ago and below the average of 3.08 percent in 2008 when the credit market seizure led investors to seek the safety of government debt, according to Bank of America Merrill Lynch index data. The cost to borrow is steady even though the amount of bonds in the index that includes nations from the U.S. to Germany and Japan has grown to $17.4 trillion from $13.4 trillion two years ago.
While the debt helped the global economy recover from its first recession since World War II, yields show bond investors aren’t troubled that the growth will spur inflation. Consumer prices excluding food and energy costs rose 1.5 percent in February from a year earlier in the 30 countries that form the Organization for Economic Cooperation and Development, the smallest gain on record.
“The fact that inflation is very well behaved, that provides the cover for central banks to remain on the sidelines and continue to pursue accommodative policies to help the economy,” said Thomas Girard, a senior money manager who helps oversee $115 billion in fixed-income assets with New York Life Investment Management in New York.
Ending Bearish Bets
Girard is no longer bearish on Treasuries, even though some of the world’s biggest investors, including Bill Gross, manager of the world’s biggest bond fund, say the best is over for bonds. Girard extended the duration of the U.S. Treasuries he oversees this month to match that of benchmark indexes from a so-called underweight position.
Steady yields are helping U.S. President Barack Obama, German Chancellor Angela Merkel, U.K. Prime Minister Gordon Brown and Japan Prime Minister Yukio Hatoyama finance deficits and spur their economies.
The U.S. paid $383.4 billion in interest on its debt in fiscal 2009 ended Sept. 30, down from $451.2 billion in the previous year, according to the Treasury Department. That represented 3.2 percent of gross domestic product, down from 4.6 percent a decade earlier, when Bill Clinton was president and the U.S. had a budget surplus.
Auction Demand
Demand for U.S. government bonds is increasing. On average, the Treasury received $3.21 in bids for each dollar sold at 10- year auctions this year, compared with $2.63 in 2009 and $2.41 from 2004 through 2008, according to data compiled by Bloomberg.
“Part of what’s frustrated bond vigilantes has been that economic data has ratified the notion of modest growth and continued declining inflation,” said Wan-Chong Kung, a money manager who helps oversee $89 billion at FAF Advisors in Minneapolis, the asset-management arm of U.S. Bancorp.
The term bond vigilantes was coined by economist Edward Yardeni in 1984 to describe investors who protest monetary or fiscal policies they consider inflationary by selling bonds.
Economists at the securities unit of London-based Barclays Plc, Britain’s second-largest bank, forecast in an April 23 research report that inflation in developed nations will hold steady at an annual rate of 1.5 percent through the end of the year before slowing to 1.4 percent in mid-2011.
Bernanke’s ‘Moderation’
Federal Reserve Bank of Atlanta President Dennis Lockhart said in an April 15 speech that he is paying “serious attention” to disinflationary pressures. The “moderation in inflation has been broadly based,” Fed Chairman Ben S. Bernanke said a day earlier in testimony to Congress.
Consumer prices rose 1.4 percent in the 16-member euro region in March from a year earlier instead of a previously reported 1.5 percent, the European Union’s statistics office in Luxembourg said April 16. The report came a week after the Frankfurt-based European Central Bank kept its benchmark rate at a record low of 1 percent and President Jean-Claude Trichet forecast inflation will remain “moderate” through 2010.
Japan may say this week consumer prices excluding fresh food dropped for the 13th consecutive month in March, based on the median estimate of 20 economists surveyed by Bloomberg News. Traders see prices falling an average 0.9 percent annually for the next five years, yields on inflation-linked bonds show.
Expectations that yields will stay low for an extended period run counter to the outlook of Pacific Investment Management Co.’s Gross. The manager of the $219.7 billion Total Return Fund said a month ago that the bond market may have seen its best days.
‘Bear Element’
“Real interest rates are moving higher,” Gross said in a March 25 Bloomberg Radio interview from Pimco’s headquarters in Newport Beach, California. “That’s the main bear element in the bond market.”
Real yields, which take into account inflation or deflation, have increased to 1.46 percent on 10-year Treasuries from 1.03 percent at the end of last year. The mean over the past 20 years is 2.73 percent, Bloomberg data show.
The challenge facing policy makers is debt near postwar records, after governments spent trillions of dollars to revive their economies following the first global recession since World War II, the International Monetary Fund said April 21. The richest nations face growing pressure to draft plans to reduce budget deficits, while emerging economies try to fuel domestic demand and avoid asset bubbles, the Washington-based IMF said.
‘Downside Risks’
“Activity remains dependent on highly accommodative macroeconomic policies and is subject to downside risks, as fiscal fragilities have come to the fore,” the IMF said in the report.
Bond investors are focusing on those “fragilities.” Government debt as measured by Bank of America Merrill Lynch’s Global Sovereign Broad Market Plus Index has returned 1.35 percent on average this year, compared with 0.9 percent in all of 2009.
“There’s a philosophical battle between those -- and I’m in this camp -- who feel the deflationary forces are very powerful, versus those who say ‘hey, you’re printing tons of money, you’ve got to have inflation,’” said Barr Segal, a managing director at Los Angeles-based TCW Group Inc. who helps oversee $72 billion in fixed-income assets. “And they’re right, too. The big question is timing.”
Besides taxpayers, the biggest beneficiaries of low borrowing cost are companies. The average corporate bond yields 3.93 percent, down from 6.68 percent a year earlier, according to Bank of America Merrill Lynch Indexes. The drop represents annual interest savings of $27.5 million for every $1 billion borrowed by companies from Fairfield, Connecticut-based General Electric Co. to Roche Holding AG in Basel, Switzerland.
Diminished Supply
Sovereign bonds are also benefitting from diminished supply following the seizure in credit markets. While U.S. government debt outstanding has risen $1.444 trillion since 2008 to $7.68 trillion, private sector debt fell $1.86 trillion to $40.186 trillion, according to UBS Securities.
“There will be a limit to how much pure supply can push yields higher,” said David Rolley, who helps oversee $106 billion as co-head of global fixed-income in Boston at Loomis Sayles & Co. “There appear to be levels at which people are prepared to buy. For example, for the U.S. 10-year as we approach 4 percent buyers emerge.”
The benchmark 3.625 percent Treasury note February 2020 closed last week at 98 14/32 to yield 3.82 percent, down from 4.01 percent on April 5, according to BGCantor Market Data. The yield was 3.79 percent today at 8:43 a.m. in New York.
Bank Demand
Yields on Treasuries average 2.41 percent, down from last year’s high of 2.75 percent in June, Bank of America Merrill Lynch indexes show. Ten-year yields will fall to 3 percent by year-end, said Sungjin Park, head of fixed income at Samsung Investment Trust Management in Seoul, South Korea’s largest private investor, with $60 billion in debt assets.
“Currently, the main mission of the Fed is not about inflation,” Park said. “It’s the recovery of the U.S. economy. Low yields help the Fed spur growth.”
German bunds yield 2.13 percent, down from last year’s high of 2.89 percent amid Greece’s worsening debt crisis.
Japan’s bonds yield 0.81 percent on average, compared with last year’s peak of 1.05 percent. Bank of Japan Deputy Governor Kiyohiko Nishimura said April 21 that the country’s recovery is beginning to stem deflation and the central bank should persist with its accommodative monetary policy.
“Some beams of light are starting to break through a thick cloud of deflation,” Nishimura said in a speech in Sendai, northern Japan. “The effects of the pickup in the economy since the spring of 2009 can be considered to spread over to prices only from now on.”
U.K. Gilts
Yields on U.K. gilts average 3.53 percent. While up from 3.21 percent a year ago, it’s down from 3.66 percent in July. The Office for National Statistics in London said last week that Britain had a budget deficit of 152.8 billion pounds ($234 billion) in the fiscal year ended March 31, an increase of 76 percent.
The Bank of England’s Monetary Policy Committee voted 9-0 to keep rates at a record low 0.5 percent because data in the previous month hadn’t changed enough to “substantially alter” its view of the economy, minutes of the April 8 meeting released April 21 in London showed.
“The size of the output gap in the U.K. is pretty substantial,” said Robin Marshall, who helps oversee $20 billion as director of fixed income at Smith & Williamson Asset Management in London. “There is a still huge amount of unused capacity bearing down on inflation here, and indeed elsewhere in most major markets.”
To contact the reporter on this story: Daniel Kruger in New York at dkruger1@bloomberg.net.
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