U.S. Treasuries Benefiting From a Rising Dollar, Increased Foreign Demand

Aug. 22 (Bloomberg) -- U.S. Treasuries are benefiting a rising dollar and yields that are higher than on comparable German, Canadian and Japanese government bonds. The Federal Reserve's holdings of Treasuries for foreign central banks and international accounts rose $7.2 billion to $1.10 trillion in the week ended Aug. 17, the biggest increase since February. A Japanese government report last week showed the country's investors doubled their purchases of overseas bonds. Treasury notes maturing in 10 years rose the past two weeks on speculation international investors, owners of about half the U.S. government's $4 trillion in debt, will keep buying. The notes haven't climbed for three weeks since October. The dollar last week had its biggest gain against the euro in more than two months, enhancing returns for international investors who own U.S. debt. "We're got a reasonably positive view of bonds at the moment,'' said Julian Foxall, who helps manage about $10.5 billion of bonds at Pimco Global Advisors Ltd. in Sydney. "The Fed has been raising rates for some time now and the 10-year yield just hasn't moved over the whole period. We think that scenario will continue.'' Yields on benchmark 10-year Treasuries have declined to 4.21 percent, the lowest since July, from 4.39 percent on Aug. 5. Yields move inversely to bond prices. The 4 1/4 percent note due in August 2015, ended last week at 100 3/8, up about 1/4, or $2.50 per $1,000 face amount. Against the euro, the dollar gained 2.4 percent to $1.2154 last week. It has risen 12 percent from a record low of $1.3666 on Dec. 30.

High Yield Market

The two-week rally narrowed the gap between 10-year U.S. and German government bond yields to 1 percentage point, down 5 basis points from a five-year high reached on Aug. 8. Yields on 10-year Treasuries exceed those on bonds sold by every other Group of Seven country except the U.K. A year ago, they were higher than just half the G7. British 10-year gilts yield 6 basis points more than Treasuries, down from 74 basis points a year ago. A basis point is 0.01 percentage point. The U.S. has become the "the high yield market'' of choice for investors, said Richard Gilhooly, government bond strategist in New York at BNP Paribas SA, France's second-biggest bank. The firm is one of the 22 primary dealers of U.S. government securities that are required to bid at Treasury auctions. Surveys show a rising enthusiasm for U.S. debt. Ried, Thunberg & Co.'s index on the outlook for the 10-year note is at 49, the highest since March 2004, and up from a low this year of 38. The 36 international investors surveyed by the Jersey City, New Jersey-based bond-research firm manage $1.3 trillion. A reading below 50 indicates participants expect the note's yield to rise by the end of September.

Fed Expectations

Buying Treasuries and selling European government bonds may be "one of the top trades for 2006,'' as the Fed increases in overnight lending rates damp economic growth just as Europe's expansion accelerates, debt strategists at Merrill Lynch & Co. said last week. "Our worry is that the Fed overdoes it,'' said Kenneth Taubes, who oversees $16 billion in bonds at Pioneer Investment Management in Boston. "They are certainly showing no signs of being finished here.'' The Fed on Aug. 9 raised its benchmark rate by a quarter point to 3.5 percent, the 10th increase since June 2004. A Bloomberg survey of the primary dealers earlier this month found that 20 expected the central bank to increase the so-called federal funds rate to at least 4 percent by year-end. Fed policy makers, even amid concern that record high energy prices will slow the economy, repeated a plan to push rates higher at a "measured'' pace. Ried Thunberg reported 72 percent of its survey respondents said near-record energy prices are beginning to impede economic activity.

Oil and Inflation

Crude oil for September delivery reached an all-time high of $67.10 on Aug 12. Wal-Mart Stores Inc., the world's largest retailer, last week said its second-quarter profit rose by the smallest amount in four years, slowed by record gasoline prices. The Fed reiterated that inflation expectations were "well contained,'' a surprise to some investors who expected the central bank to be more concerned after a six-week slide in Treasuries sparked by increases in employment, manufacturing and consumer spending. The 10-year Treasury yield was 4.44 percent before the central bank's Aug. 9 statement, "It's a very dovish, soft-handed approach when people were expecting a slap on the behind,'' said David Petrosinelli, who manages $5 billion of bonds at Shay Assets Management Inc. in Chicago.
Consumer prices, excluding food and energy, rose 0.1 percent in July, the same as in June, the government said last week. A 0.2 percent increase was the median forecast in a Bloomberg survey of 63 economists. U.S. debt prices also rose last week after Japan's Ministry of Finance said on Aug. 18 the nation's investors bought a net 154 billion yen ($1.39 billion) of foreign bonds in the week ended Aug. 13, the most since the week ended July 23. "It could be the increase of the U.S. interest rate in the longer-term'' that makes Treasury yields attractive, said Takahira Ogawa, director of sovereign ratings at Standard & Poor's International in Singapore. Ten-year Treasuries yield 2.79 percentage points more than the Japan's 10-year bonds, up from the past year's low of 2.5 percentage points reached on Oct. 22.