Banks Buying Treasuries Help Keep Borrowing Rates Low (Update1)
By Cordell Eddings
May 3 (Bloomberg) -- Bank are increasing purchases of U.S.government securities to pump up profits while lending tobusinesses languishes near the lowest levels since creditmarkets started to freeze almost three years ago.
Holdings of Treasuries rose each of the past five weeks,an increase of $63.2 billion to $1.5 trillion, according toFederal Reserve data. At the same time, commercial andindustrial loans climbed less than 1 percent to $1.27 trillionand are down 23 percent from the record high level in October2008.
Banks, facing increased regulation after posting $1.78trillion of writedowns and losses since the start of 2007, aretaking advantage of the record gap between their borrowingcosts and yields on U.S. debt instead of lending, according todata compiled by Bloomberg. Bank demand for Treasuries ishelping cap yields as President Barack Obama sells recordamounts of bonds to finance a budget deficits that exceeds $1trillion.
“The risk of owning Treasures is lower than creatingloans,” said Anthony Crescenzi, a market strategist and moneymanager at Newport Beach, California-based Pacific InvestmentManagement Co., the world’s largest bond-fund manager. “Thereis no clarity on what the capital climates will be domesticallyor on a global scale with regulation coming down the pipes,which means banks will be banking their money in saferassets.”
Treasury Auctions
Yields on benchmark 10-year Treasury notes fell 15 basispoints last week to 3.66 percent, the biggest decline sinceFebruary, according to BGCantor Market Data. The yield is downfrom the high this year of 4.01 percent on April 5.
Treasury futures contracts dropped for the first time inthree days today. The implied yield on 10-year contracts forJune delivery climbed to 3.85 percent as of 9:24 a.m. inSingapore, from 3.83 percent at the end of last week. The pricefell 6/32, or $1.88 per $1,000 face amount, to 117 23/32.Trading of Treasury bills, notes and bonds is closed today inJapan and the U.K. for holidays.
Investors piled into U.S. debt last week as expandingdeficits raised concerns about Europe’s economy. Standard &Poor’s lowered Greece’s credit rating to below investment grade,and cut Portugal and Spain.
Credit Spread
The MSCI World Index of stocks fell 2.19 percent, thebiggest drop since the period ended Jan. 29. Yields oncorporate bonds rose the most in 13 months relative togovernment debt, according to Bank of America Merrill Lynch’sGlobal Broad Market Corporate Index.
“After a long period of stability and steady decline inrisk aversion, sovereign concerns in Europe have attractedattention threatening to unwind the trend,” Anshul Pradhan, adebt strategist at Barclays Plc in New York, said in a researchreport dated April 30.
Banks increased demand at the Treasury’s auctions of 10-and 30-year securities in March. They bought a record $2.562billion, or 12 percent, of the 10-year notes sold on March 10,and $3.146 billion, or 24 percent, of the 30-year bonds offeredthe next day, government data show. Banks typically made upless than 1 percent of the demand for longer maturity debt.
‘Yield Grab’
“As long as we are not lending this is what we will see --the yield grab,” said George Goncalves, head of interest ratestrategy in New York at Nomura Holdings Inc., one of 18 primarydealers that are required to bid on Treasury auctions. “If youaren’t worried about inflation and you don’t think demand forlending is going to pick up than the long end is where you wantto be,” he said, referring to longer-maturity bonds.
Low yields are helping taxpayers. In fiscal 2009 endedSept. 30, the U.S. paid $383.4 billion in interest on its debt,down from $451.2 billion the previous year, Treasury data show.That represented 3.2 percent of gross domestic product, downfrom 4.6 percent a decade earlier, when Bill Clinton waspresident and the U.S. had a budget surplus. The amount forfiscal 2010 through September was $201.9 billion.
Financial institutions have little incentive to extendloans with unemployment hovering at about 10 percent and thedifference between the rate on overnight loans between banksand 10-year Treasuries yields at about 3.5 percentage points.That’s more than double the average of 1.55 percentage pointsover the past 20 years.
Real Yields
Real yields, which take into account inflation ordeflation, are 1.36 percent on 10-year Treasuries, comparedwith the mean of 2.71 percent the past 20 years, Bloomberg datashow. The U.S. economy expanded at a 3.2 percent annual rate inthe first quarter and capped the biggest six-month gain since2003, the Commerce Department reported April 30.
“If you look at the economy you are either glass halffull or glass half empty -- lenders are the latter right now,”said Keith Leggett, senior economist at the American BankersAssociation in Washington. “There isn’t a lot of demand fromcreditworthy borrowers. You can lead a horse to water but youcan’t make him drink. The environment has been made veryfavorable for borrowing but creditworthy households andbusinesses are still reluctant to borrow.”
Rising Profits
Bank of America Corp., JPMorgan Chase & Co., Citigroup Inc.and Wells Fargo & Co., beneficiaries of $140 billion intaxpayer funds, had combined first-quarter profits of $13.4billion, the most since the second quarter of 2007 before thecrisis began, bolstered by fixed-income trading.
The increase in government debt comes as banks shrinktheir balance sheets for the first time since the GreatDepression, further restricting lending, particularly for smallbusinesses that rely on banks for financing, according to BrownBrothers Harriman & Co.
“Banks are stepping up purchases of government bonds butstill not buying government bonds in sufficient size to offsetthe decline in their loan portfolios.” said Jeffrey Schoenfeld,partner and chief investment officer in New York at BrownBrothers, which manages $33 billion in assets. “This is acontinued headwind to lending.”
‘Extended Period’
The relationship between short- and long-term rates maynot change anytime soon. Fed officials restated their intentionlast week to keep the target federal funds rate in a range ofzero to 0.25 percent for an “extended period.”
“Economic conditions, including low rates of resourceutilization, subdued inflation trends, and stable inflationexpectations, are likely to warrant exceptionally low levels ofthe federal funds rate for an extended period,” the FederalOpen Market Committee said in a statement on April 28.
While the U.S. savings rate was 3.1 percent in February,down from 6.4 percent in May, the highest level since 1993,it’s up from zero in April 2008. Deposits totaled $7.6 trillionon April 7, $691 billion more than outstanding loans, Bloombergdata show.
Savings plus $1 trillion pumped into the financial systemover the past year by the Fed through bond purchases andemergency loans led banks to accumulate excess reserves of$1.055 trillion. The cash banks keep on deposit above what isrequired by the central bank averaged $1.7 billion in the fiveyears to August 2007.
Reminiscent of Japan
Buying longer-term debt is reminiscent of Japan, wherebanks increased their holdings of government bonds to recordlevels during the country’s so-called lost decade of economicstagnation that began in the 1990s, according to Michael Cheah,who manages $2 billion in bonds at SunAmerica Asset Managementin Jersey City, New Jersey.
Like Japan’s response to the real estate collapse in the1990s, the U.S. flooded the economy with cash only to seefinancial institutions sock the money away in bonds instead ofmaking loans. Yields on 10-year Japanese bonds ended last weekat 1.27 percent.
“It’s the Japanese movie, just an American version,”said Cheah, who worked for Singapore’s central bank. “The nextscene is that after banks buy more and more government bonds itwill be very difficult for the Fed to raise interest ratesbecause they will lead to massive losses in the banks and causethem trouble all over again.”
