Bloomberg -- The world’s biggest investors are finding U.S. government bonds becoming safer, not more risky, as the deadline to avoid the first American default approaches.
The yield on 10-year U.S. bonds dropped to a two-month low of 2.58% on Oct. 3, after Treasury Secretary Jacob J. Lew said the government won’t be able to pay its debts in 14 days unless Congress raises the $16.7 trillion borrowing ceiling. While short-term bill rates and the cost to insure against a default have risen, volatility in Treasuries has fallen, a sign that investor confidence in the Federal Reserve is outweighing worries over the budget battle among U.S. political leaders.
BlackRock Inc. Chairman and Chief Executive Officer Laurence D. Fink and Pacific Investment Management Co. Co-Chief Investment Officer Bill Gross, who lead the world’s biggest bond firms, dismiss the possibility of a default after the first government shutdown in 17 years as House Republicans failed to agree on a budget with Senate Democrats and President Barack Obama. With the closures shaving at least 0.1% off economic growth each week, Fed policy makers said they will probably keep buying $85 billion a month of bonds.
“The dysfunction in Washington just makes the Fed more likely to be supportive of the market,” Mark MacQueen, a partner and money manager in Austin, Texas, at Sage Advisory Services Ltd., which oversees $11 billion, said in a telephone interview Oct. 1. “We should stick to the underlying economic fundamentals and not worry about 72 hours in Washington. The real fear of a major rate increase is diminishing as long as this nonsense continues.”
MacQueen is buying corporate bonds and mortgage securities because they are worth the risk as alternatives to Treasuries, which make up about 25% of his holdings. Investment-grade U.S. corporate bonds offer about 146 basis points, or 1.46%age points, of extra yield compared with government debt, according to Bloomberg indexes.
Investors are showing confidence in Treasuries by pushing down two main risk measures. Three-month volatility on five-year interest rate swaps has decreased about 35% since last month. The gauge, a measure of projected yield fluctuations over the next 90 days, dropped to 79 basis points Oct. 4, from 123 basis points reached Sept. 5.
The MOVE Index, which uses options prices to project price swings in Treasuries across a range of maturities, declined 31% to 80 on Oct. 3, from 114 on Sept. 5. The 2013 average is 72.
Treasuries were little changed last week, with 10-year yields rising 2 basis points, or 0.02 percentage point, to 2.65%, according to Bloomberg Bond Trader prices.
The yield on U.S. 10-year notes fell four basis points to 2.61% at 8:43 a.m. New York time. Lew said Congress needs to pass a debt-ceiling increase by Oct. 17 or the U.S. will be “dangerously low” on cash, speaking yesterday on CNN’s “State of the Union.”
“It’s a strange situation where the bigger the risk of the debt ceiling gets, the more Treasuries seem to benefit,” John Wraith, a fixed-income strategist at Bank of America Corp. in London said by phone today. “There’s a firm belief that ultimately this will get resolved one way or another, but in the interim it dampens the growth outlook and increases the chance the Fed will have to keep its foot down for longer.”
The 10-year yield has dropped since reaching a two-year high of 3.01% on Sept. 6. While the median estimate of more than 60 economists in a Bloomberg survey is for it to rise to 3.36% by the end of 2014, that would still leave it below the average over the past decade of 3.53%.
“What we have seen in times of crisis, whether it’s geopolitical or purely political, or economic, there tends to be a flight to quality,” James Sarni, senior managing partner in Los Angeles at Payden & Rygel, which manages $85 billion, said in a telephone interview Oct. 2. “The market is not pricing in a high probability of a default,” he said. “The market is ignoring Congress because they’ve lost confidence in them.”
The drop in Treasury yields contrasts with the increase in some European bond rates as nations there grapple with rising debt loads and political instability. During the height of the region’s sovereign crisis in 2011 and 2012, yields on 10-year notes of Greece, Ireland, Portugal, Spain and Italy all exceeded 7%, according to data compiled by Bloomberg.
Italy’s 10-year note yield rose on Sept. 30 to 4.66%, the highest level since June 27 as Prime Minister Enrico Letta said he would request a confidence vote on Oct. 2 following Silvio Berlusconi’s withdrawal of support for the nation’s five-month-old administration.
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