Treasury Bids Rise 18% as Investors Surpass Dealers

July 19 (Bloomberg) -- For the first time since the government started collecting the data, central banks, mutual funds and U.S. banks are buying more government securities at Treasury auctions than Wall Street’s bond dealers.

Foreign and domestic investors bidding directly at note and bond auctions bought 57 percent of the $1.26 trillion in Treasuries sold by the government this year, up from 45 percent during the same period in 2009 and as little as 32 percent for all of 2008, according to government data compiled by Bloomberg. Bids compared with the amount of debt sold, the bid-to-cover ratio, rose 18 percent from last year’s 14-year high, according to data that Treasury started collecting in 1994.

The combination of the lowest U.S. inflation rate in four decades and continuing concerns that the global recovery will falter is boosting bonds even as yields on 10-year notes fall below 3 percent, the lowest since April 2009. The surge in demand through so-called direct and indirect bids is helping drive down rates for U.S. President Barack Obama as he grapples with a budget deficit that’s forecast to swell 14 percent to a record $1.6 trillion.

“The economic backdrop is favorable for Treasuries,” said Thomas Girard, who helps manage $115 billion in fixed income at New York Life Investment Management in New York. “There’s no fear of inflation. The bigger fear is deflation.”

Consumer Confidence Tumbles

Yields on 10-year notes fell 13 basis points last week to 2.92 percent, according to BGCantor Market Data. That’s 88 basis points above the record low of 2.04 percent reached on Dec. 18, 2008, after the collapse of New York-based Lehman Brothers Holdings Inc. spurred investors to seek only the safest government securities.

The two-year yield dropped to an all-time low of 0.577 percent on July 16 as a report showed confidence among U.S. consumers tumbled to the lowest level in a year.

Trading of bills, notes and bonds was shut in Japan today for a holiday.

The Thomson Reuters/University of Michigan preliminary index of consumer sentiment decreased to 66.5, the lowest since August and less than the most pessimistic forecast of economists surveyed by Bloomberg News. Consumer prices excluding energy and food remained at a 44-year low of 0.9 percent in June for a third consecutive month, the Labor Department said the same day.

The drop in sentiment followed the Labor Department’s July 2 report showing that the U.S. lost 125,000 jobs in June, the first decline since December. Retail sales excluding autos have slid for two consecutive months for the first time since 2008, while new home sales plunged to a record low in May after reaching a 20-month high of 446,000 in April.

U.S. GDP

The American economy grew 2.7 percent in the first three months of 2010, expanding for a third straight quarter after the longest recession since the Great Depression. U.S. gross domestic product will increase 3.1 percent this year, according to estimates from 54 economists compiled by Bloomberg.

“The data shift that we had from the first quarter to the second quarter has been fairly dramatic and came sooner than many investors would have expected,” said Eric Pellicciaro, New York-based head of global rates investments at BlackRock Inc., which manages about $1 trillion in bonds. “Treasuries are still attractive.”

Even bond-market bears such as primary dealer Morgan Stanley have trimmed forecasts for U.S. yields to rise in the second half of the year, with slow growth likely to keep the Federal Reserve from increasing record low borrowing rates into 2011. The target for overnight loans between banks has been zero to 0.25 percent since December 2008.

Primary Dealers

Morgan Stanley of New York has lowered its estimate for the 10-year note’s yield at the end of the 2010 to 3.5 percent from 5.5 percent at the start the year. The median projection of 55 forecasts in a Bloomberg News survey is 3.36 percent, down from 3.80 percent in June.

Primary dealers, which are required to bid in government auctions and act as the trading partner to the New York Fed, have won the lowest proportion of Treasuries in auctions since the government began releasing the data in 2003.

Increasing demand for longer-term debt from central banks moving out of the euro and into dollar assets has helped keep yields low, said Jeffrey Rosenberg, a credit strategist at Charlotte, North Carolina-based Bank of America Corp. China holds $867.7 billion of Treasuries, making it the biggest lender to the U.S.

“The auction participation data and the holdings data show an increase in holdings in the long-term,” said Rosenberg. International investors have displayed “comfort with moving out the curve,” he said.

China’s Holdings

Purchases by China in recent months have focused on longer- term debt, unlike in 2008, when most of the cash went into Treasury bills. While China has slashed its bill holdings by nine-tenths to $6.8 billion as the global credit crunch eased, total holdings are up 8.3 percent in the 12 months through May, with notes and bonds due in two years or more surging 46 percent, the Treasury said July 16.

Custodial holdings of Treasuries at the Fed for accounts including central banks have increased 4.7 percent this year to a record $2.29 trillion.

“This has been a pretty ferocious flight-to-quality,” said Wan-Chong Kung, who helps manage $89 billion at FAF Advisors in Minneapolis, the asset-management arm of U.S. Bancorp. “Investors more broadly are embracing the idea of a slower U.S. economy where inflation is not a problem.”

‘Paralyzed With Uncertainty’

Spending by companies and consumers has slowed as economic data has shown signs of weakening. Companies in the Standard & Poor’s 500 Index have stockpiled a record $2.3 trillion of cash and equivalents. At the same time, consumer credit has declined in 15 of the last 16 months, while factory orders fell 1.4 percent in May, the biggest drop in 14 months, the Commerce Department said.

Companies “are paralyzed with uncertainty,” said Barr Segal, a managing director at Los Angeles-based TCW Group Inc., who helps oversee $72 billion in fixed-income assets. “They’re sitting on cash. There’s a lot of powder there that’s going nowhere. It is in a way deflationary.”

Almost 87 percent of the 23 companies in the S&P 500 that reported earnings since July 12, including Alcoa Inc. of New York and Santa Clara, California-based Intel Corp., have beaten analysts’ forecasts for earnings per share, data compiled by Bloomberg show. General Electric Co. in Fairfield, Connecticut, Bank of America and four other companies reported sales that trailed projections.

Earnings Projections

While analyst estimates compiled by Bloomberg show that profits at S&P 500 companies are forecast to increase by 34 percent in 2010 and 18 percent in 2011, investors remain concerned the earnings expansion is being driven by cost reductions rather than sales growth, Segal said.

Investment funds and U.S. banks have been among the biggest direct buyers of Treasuries this year. Banks held $1.48 trillion in Treasuries and agency debt as of June 30, up 2.1 percent from the end of 2009, according to Fed data.

Depository institutions bought $1.2 billion of the $13 billion in 30-year U.S. bonds auctioned on June 10, $3.1 billion of those offered on March 11 and $2.7 billion of the $16 billion sale on Feb. 11, Treasury data show.

“There is definitely a sense that banks are reluctant to lend and are parking reserves either at the Fed, in Treasuries or other non-consumer lending assets,” said Ian Lyngen, a government bond strategist at CRT Capital Group LLC in Stamford, Connecticut. “Banks have tightened their standards and even if their standards remained the same, the position of consumers has deteriorated with the economy under stress. It’s more difficult to get a car loan, it’s more difficult to get a mortgage.”

Auctions Peak

Company borrowing slid 29 percent in the first half of the year to $528 billion amid a dearth of business investment, Bloomberg data shows.

The drop in debt issuance comes with Treasury auctions starting to decline after reaching record levels. Monthly fixed- coupon sales of Treasuries decreased 7.3 percent to $178 billion in June from $192 billion in April.

Primary dealers told U.S. officials in February that the increase in direct bids from investors at auctions risked distorting prices in the $7 trillion market for U.S. government debt, according to people involved in the discussions at the time. The firms said the rise in direct bids may increase borrowing costs for the Treasury and taxpayers if dealers bid less aggressively because of higher volatility at the sales.

‘Bidding Behavior’

“The change in bidding behavior should increase the volatility around auctions,” Joe Leary and Brett Rose, New York-based strategists at primary dealer Citigroup Inc., wrote in a July 14 report. “A counter effect that comes along with an increased number of direct bidders is increased competition. This recent change in auction behavior may not be completely adverse for Treasury borrowing costs.”

The U.S. deficit rose $68.4 billion in June to $1 trillion for the fiscal year that ends Sept. 30, the government said July 13. Tax receipts have increased 0.5 percent to $1.6 trillion while spending has declined 2.8 percent to $2.6 trillion.

The S&P 500, the benchmark gauge for U.S. equities, has fallen 4.5 percent this year while Treasuries have risen 6.2 percent, according to Bank of America Merrill Lynch indexes.

Globally, bond returns topped stock gains by the widest margin in nine years in the first half as optimism about the global economic recovery waned.

The MSCI World Index of 24 developed countries fell 9.5 percent, including dividends, in the first half of 2010, while bonds gained 4.2 percent, the Bank of America Merrill Lynch Global Broad Market Index shows.

“The bond market has finally come to the conclusion that we’re going to have shallow growth and low inflation for years to come,” said George Goncalves, head of interest-rate strategy at Nomura Holdings Inc. in New York. “That’s being manifested in the auction process. It’s a bullish environment for Treasuries.”