Banks step up their buying of Treasuries--that's good and bad news

05/04/2011 3:36 pm EST

Focus: STOCKS

Jim Jubak

Founder and Editor, JubakPicks.com

This is only half as reassuring as it seems to be.

If you’ve wondered (worried) about what buyers are going to step in when the U.S. Federal Reserve stops its program of buying Treasury bonds at the end of June, well, now we’ve got part of an answer.

Banks.

U.S. banks are buying U.S. government debt at the fastest pace in nine months. In the last seven weeks, according to the Federal Reserve, U.S. commercial banks bought $65 billion in U.S. debt. That’s the most since the $79 billion they bought in the seven weeks that ended on July 21.

However, the reason that banks are buying is anything but reassuring.

U.S. banks are buying Treasuries because they think the U.S. economy is going to slow. Bank economists are lowering their forecasts for U.S. GDP growth as rising gasoline prices cut into disposable income and falling housing prices continue to erode family wealth and consumer confidence.

These are just projections, of course, but bank economists sit in a good position to detect changes in the economy. They can look at the loan books at their own and other banks to see if the economy is growing or slowing. And what they’re seeing right now isn’t especially reassuring. Bank loan portfolios are falling. Analysts at JPMorgan Chase (JPM) wrote in an April 29 report that total loans at the 30 banks they cover fell by 1.08% in the first quarter of 2011. That’s after an increase of 0.14% in the fourth quarter. (Investors have been seeing the same thing this quarter in bank earnings reports. U.S. Bancorp (USB) stood out in the group because it saw any loan growth at all in the first quarter. Most banks reported that lending was down. Loan growth at U.S. Bancorp, however, was just 0.7% for the quarter.)

Total bank loan books are up 3.5% from September 2010. (That tiny percentage figure comes to $1.25 trillion.) But that’s still 23% below the October 2008 peak.

The yield on the benchmark 10-year Treasury fell slightly to 3.29% last week. That doesn’t seem like much of a return, especially when banks are taking a risk that interest rates will go higher and drive down the value of their bonds. According to a survey by Bloomberg, the average forecast is for a 3.93% yield by the end of 2011.

But it’s not like banks have a whole lot of options here. If the economy is slowing, commercial loans, with their risk of default, aren’t all that attractive. (Even if companies were eager to borrow and banks say they’re not.) The real estate market is still struggling; that reduces the amount of high-rated mortgage debt available for purchase. Consumers are paying off debt. That has reduced the volume of offerings of bonds backed by consumer loans to a piddling $35 billion so far in 2011. That compares to $184 billion in 2009.

All this makes Treasuries one of the few games in town. Especially if you’re a bank trying to find high quality assets to meet the new Basel III rules for capital. Under the rules banks will have to keep less in reserve, if they hold high quality assets such as Treasuries. The Treasury Advisory Committee forecasts that banks may need to buy as much as $1.6 trillion in Treasuries over the next five years to meet these rules.

All this is good news for the end of the Fed’s program of quantitative easing. But not a good indicator for economic growth or for bank earnings in the rest of 2011 and beyond.

 

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