Dollar Suffers on Treasury Holders' Big Bet
04/12/2011 3:20 pm EST
So why is it that US bond prices aren’t sinking? More important, why is it that US bond yields aren’t sinking?
It can’t be that overseas investors found last week’s near-shutdown of the US government a reassuring sign of Washington’s fiscal responsibility.
Yields on US bonds are lower now than when the government was running a budget surplus a decade ago—and when the amount of US government debt outstanding was much, much lower. Marketable debt outstanding has climbed to $9.13 trillion, from $4.34 trillion in the middle of 2007.
But the yield on the benchmark ten-year Treasury is just 3.49% as I post this on April 12. The average yield from 1998 through 2001, according to Bloomberg, was 5.48%.
And overseas investors aren’t fleeing the US Treasury market. Foreign central banks bought 60% of the $66 billion in ten-year notes sold this year, up from 42% in 2010, according to the US Treasury. Foreign investors as a whole owned $4.45 trillion in Treasuries as of January 2011, up from $3.7 trillion in January 2010.
The market certainly doesn’t seem to be worried about the chances of a US default. Credit-default swaps on US Treasuries—a kind of insurance against a bond issuer defaulting—stand at 0.415 percentage points. That’s a drop from the 2011 high of 0.515 on January 27.
I can think of two explanations for this—and, no, neither of them depends on overseas investors thinking US politicians are any better at economics than they actually are.
1. Your Move, Fed
First, the extremely low US interest rates are a bet on a slowing of the US economy, and the postponement of the day that inflation climbs high enough to force the Federal Reserve to raise its rates.
Inflation in the United States—or at least inflation in the way the Federal Reserve counts it—isn’t high enough now to push the Fed into raising interest rates before the very end of 2011 or, more likely, 2012.
And if—as it now seems—the Federal Reserve is worried about the likelihood that spending cuts at the federal and state levels will cut into economic growth, bond investors don’t have to worry about any early end to the Fed’s program of quantitative easing, or any significant tightening of the money supply.
In other words, low US interest rates have more to do with slow economic growth and the low likelihood of Federal Reserve tightening or interest-rate increases than they do with faith that sound fiscal policies will emerge from Washington.
2. Kicking the Dollar While It’s Down
Second, financial markets are punishing the US dollar instead of Treasury bonds. The Dollar Index, which tracks the value of the dollar against a basket of six currencies, dropped to 74.73 earlier today. That’s barely above the two-year low of 74.17 from November 2009.
That low is the last significant support above the all-time low of 70.69, set March 8, 2008.
Think about this: The euro, with all its problems, has rallied back against the dollar to the $1.45 level for the first time since January 2010. The yen is flat against the dollar this morning, even after the Japanese government raised the danger level at the Fukushima reactors to Chernobyl levels.
It might not seem especially logical that the bond and dollar markets should be giving such different reads on investor attitudes toward US debt and fiscal policy. But the currency and bond markets operate with different lags—it’s easier to change a currency bet for or against the dollar than it is to reallocate a bond portfolio.
Bond investors would prefer not to believe the worst about US fiscal policy until they must. Figuring out where else to put the $4.5 trillion in US Treasuries owned by overseas investors presents quite a headache—especially because there are, as of yet, no good alternatives.
Full disclosure: I don’t own shares of any of the companies mentioned in this column in my personal portfolio. The mutual fund I manage, Jubak Global Equity Fund (JUBAX), may or may not now own positions in any stock mentioned in this column. The fund did not own shares of Cisco Systems as of the end of January. For a full list of the stocks in the fund as of the end of January, see the fund’s portfolio here. An updated list of the fund’s holdings through the end of March will go up this week.