US Treasuries Poised for Biggest Quarterly Advance Since '02

[HenryTo]

Quote: Ried, Thunberg & Co.'s weekly index of investor sentiment toward Treasuries through year-end is at 45, the highest since March 2004. The 46 international investors polled by the Jersey City, New Jersey-based bond research firm manage $1.28 trillion.

Looks like there is still a lot of short capitulation in the Treasury markets.
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U.S. Treasury Securities Poised for Biggest Quarterly Advance Since 2002
June 27 (Bloomberg) -- Treasury securities are headed for their best quarter since 2002 on speculation slowing growth in Europe will hurt the U.S. economy.

``We're in the midst of what appears to be a synchronized global downturn,'' said Lacy Hunt, chief economist at Hoisington Investment Management in Austin, Texas. The firm's $63 million in assets Wasatch-Hoisington U.S. Treasury Fund has returned 12.6 percent this year, beating 99 percent of similar funds tracked by Bloomberg.

The benchmark 10-year Treasury note last week had its biggest rally since April, sending the yield down about 15 basis points to 3.92 percent. A basis point is 0.01 percentage point. Yields, which move inversely to prices, are benchmarks for corporate and consumer borrowing.

U.S. yields followed European and U.K. debt yields lower on rising speculation the European Central Bank and the Bank of England will lower interest rates this year to spur their economies. Minutes of policy meetings showed that two of nine members of the U.K.'s central bank voted in June for a rate cut.

Last week, the French government pared its growth forecast and Italy said consumer confidence fell to a nine-month low in June. A slowing economy makes bonds more attractive than stocks and reduces the threat that inflation will erode the value of fixed-income payments.

The Paris-based Organization for Economic Cooperation and Development's ``world leading index, which a year ago was showing a 7 percent rate of growth, is now flat -- dead flat,'' Hunt said, calling it a sign of economic ``problems as we move down the road.''

Performance

Treasuries have returned 3.68 percent since March, including reinvested interest, rebounding from a loss of 0.70 percent last quarter, according to Merrill Lynch & Co. index data. The performance is the best since returning 7.23 percent in the three months ended Sept. 30, 2002.

``The momentum of economic growth in Europe has definitely slowed, and that could lead to the ECB cutting rates, and a spillover effect to the U.S.,'' said Michael Materasso, who is betting European debt will outpace U.S. bonds with the $17 billion he oversees at Fiduciary Trust Co. in New York.

The 10-year note is down more than 50 basis points this quarter. It has ranged this year from a low of 3.80 percent on June 3 to a high of 4.69 percent on March 23. The price of the 4 1/8 percent note due in May 2015 ended last week at 101 21/32.

This quarter's performance compares with the 2.96 percent average return for 19 major government debt markets tracked by Merrill Lynch. It also tops the 1.36 percent return, including dividend payments, for the Standard & Poor's 500 Index.

The European Commission will probably cut its 2005 growth forecast for the third time in eight months as record oil costs weigh on the economy of the dozen countries that use the euro, European Union Monetary Affairs Commissioner Joaquin Almunia said in a June 25 interview.

Turning Bullish

Hoisington's Hunt said record oil prices were ``wrecking the budgets of a lot of modest family incomes and also playing havoc with the business sector.'' The firm's fund returned 10.1 percent last year, tops among government bond funds.

Citigroup Inc., the world's largest bank, last week reduced its estimate for yields in the U.S. and Europe. Economists at the New York-based bank said in their monthly outlook they now expect a 10-year yield of 4.35 percent in the fourth quarter, down from its 4.5 percent forecast one month ago.

In January, Citigroup forecast a 4.9 percent yield. At the time, the average estimate of 64 economists polled by Bloomberg was for the yield to rise to 4.72 percent by now. Since then, the pace of manufacturing growth has slowed each month, average monthly job creation has held steady from 2004 at about 175,000, and oil prices reached a record $60 per barrel.

Some strategists are turning bullish. Stephen Roach, chief economist at Morgan Stanley, said on May 31 the 10-year yield would fall to 3.5 percent in the coming year as a drop in economic growth in China hurts Asia and lops 0.7 percentage point off of global growth.

Lehman Wavers

Jack Malvey, chief global fixed-income strategist at Lehman Brothers Inc. in New York, said in a June 24 research note he may end his ``core short'' recommended position on Treasuries, or bets that prices will fall.

``We now side with clients who envision the endurance of this low yield regime through 2006,'' wrote Malvey, whose team has led Institutional Investor magazine's annual ranking of U.S. bond research analysts for five straight years.

Ried, Thunberg & Co.'s weekly index of investor sentiment toward Treasuries through year-end is at 45, the highest since March 2004. The 46 international investors polled by the Jersey City, New Jersey-based bond research firm manage $1.28 trillion.

Gains in Treasuries this quarter are being led by debt maturing in 10 years or more, a sign investors expect the economy will grow too slowly to spark faster inflation. The government said this month its consumer price index fell 0.1 percent in May, the first decline since July.

Fed Meeting

Federal Reserve policy makers meet this week, and 77 of 79 economists surveyed by Bloomberg expect them on June 30 to raise their target rate for overnight loans between banks to 3.25 percent from 3 percent. It would be the ninth straight increase since last June.

Interest-rate futures show traders still expect at least one more Fed rate boost this year, possibly two. Some investors said that will limit any rally in bonds.

``I'm not bearish but I'm not a raving bull either,'' said Thomas Seay, who oversees $17 billion in bonds as head of fixed- income investing at Victory Capital Management in Cleveland. ``There is nothing that tells you that the Fed is worried and that they will have to start easing.''

Ten-year yields may hover between 3.75 percent and 4.25 percent, he said.

Low global yields may favor U.S. bonds, which provide an extra 80 basis points in yield over Germany's 10-year bund and 273 basis points above similar-maturity Japanese debt. The average difference between Treasury and bund yields is the widest since 2000.

``Prospective returns look better for the U.S. relative to Europe,'' said Eugene Flood, chief executive officer at Chapel Hill, North Carolina-based Smith Breeden Associates, which has about $25 billion of assets under management. ``We're probably going to spend a lot of time'' between 3.75 percent and 4.25 percent.