Bernanke Disappoints Treasury Bulls Detecting Rebound (Update4)
By Daniel Kruger
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Jan. 22 (Bloomberg) -- Bond investors banking on a U.S. recession to sustain the biggest rally in Treasuries since 2002 may find that Federal Reserve Chairman Ben S. Bernanke has already laid the groundwork for a rebound.
The cost of borrowing dollars for three months fell below the Fed's benchmark rate last week for the first time since June 2003. The amount of commercial paper backed by assets including mortgages and credit-card receivables expanded for a third week after a five-month contraction, adding to speculation that central bankers are breaking the lending gridlock sparked by the collapse of the U.S. subprime-mortgage market.
``We're letting go of some Treasuries,'' said Mitchell Stapley, who oversees $22 billion as chief fixed-income officer at Fifth Third Asset Management in Grand Rapids, Michigan. ``Markets are clearly pricing for a recession. I don't think it's necessarily going to be long or hard or deep.''
Bernanke lowered the Fed's benchmark interest rate by three-quarters of a percentage point to 3.5 percent today in an emergency move for the first time since 2001 after stock markets tumbled from Hong Kong to London and a jump in the U.S. unemployment rate threatened to push the economy into recession. Emergency auctions coordinated by the Fed in December provided $70 billion in loans to the U.S. banking system and central banks lent a similar amount abroad.
The Fed chairman is responding as more economists and investors predict the country will enter a recession this year. He added his endorsement last week to the Bush administration's economic stimulus package, telling lawmakers as much as $150 billion would be ``significant'' and ``not window dressing.''
Curve Steepens
``It's possible that with the amount of stimulus we've seen coming from the Fed, and the talk of a stimulus package, that this ends up being a fly-by'' slowdown in growth, said Jonathan Lewis, a founding principal at Samson Capital Advisors LLC in New York, which manages $3.8 billion.
Lewis, who was bullish on Treasuries in 2007, is now selling notes that mature in five years or less and buying municipal bonds. Fifth Third's Stapley is shifting money to mortgage securities issued by Fannie Mae and Freddie Mac, the largest sources of money for U.S. home loans.
Yields on two-year notes ended last week 20 basis points lower at 2.35 percent. They fell 18 basis points today to 2.16 percent at 11:13 a.m. in New York, according to bond broker Cantor Fitzgerald LP. The price of the 3 1/4 percent security due in December 2009 rose 11/32, or $3.44 per $1,000 face amount, to 102 1/32. A basis point is 0.01 percentage point.
`Mild And Short'
Two-year Treasury yields of less than 2.5 percent indicate government securities are peaking after seven months of gains, said Gary Pollack, who helps oversee $12 billion as head of fixed-income trading at Deutsche Bank AG's Private Wealth Management unit in New York.
``That fully prices in a recession,'' he said. ``It would be a very mild and short recession if one does occur.''
Pollack, who bought U.S. government debt early this month, said he is selling Treasuries maturing in five years or less and buying bonds issued by industrial companies that may benefit from a rebound in the economy.
Corporate debt has ``gotten beaten up quite a bit, and we feel there could be some light at the end of the tunnel,'' Pollack said. Investors demand 3.3 percentage points more in yield to own corporate bonds rather than Treasuries, the most since December 2002, according to Merrill Lynch & Co. indexes.
Bush Plan
President George W. Bush said on Jan. 18 that his stimulus package should total about 1 percent of gross domestic product, which was an annualized $13.97 trillion in the third quarter. The economy will grow an average 1.5 percent in the first half of 2008, the weakest rate since 2001, according to the median estimate of 65 economists surveyed by Bloomberg from Jan. 3 to Jan. 8.
``We're certainly already in a recession-slash-depression in housing,'' said Barr Segal, a managing director at Los Angeles-based TCW Group Inc., which oversees $90 billion in fixed-income assets. ``We could fall into a recession.''
Betting on a slowdown has been profitable for bond investors. Treasuries had gained 11.8 percent on average since mid-June, when losses on securities tied to subprime mortgages began to drive investors to the safety of government debt, according to Merrill indexes. The Standard & Poor's 500 Index fell 11 percent in the same period ending Jan. 18.
Economists at Bear Stearns Cos., one of the 20 primary dealers that trade with the Fed, figure the rally in bonds may be over. The firm said last week that the economy will likely avoid recession and accelerate in the second half of the year, after the central bank cuts rates by another 1 percentage point this quarter.
`Low Points'
``We're not convinced that the drags the economy is facing, which are very significant from the housing market and the financial markets, are enough to pull the economy down into recession,'' said Conrad DeQuadros, a senior economist at the New York-based firm. ``We're viewing these yields as some of the low points we'll see.''
Fed funds futures contracts on the Chicago Board of Trade show a 70 percent chance the central bank will cut its target rate for overnight lending between banks to 3.25 percent by its Jan. 30 policy meeting.
Any contraction in the economy should be ``mild and short'' because the cuts made last year already amount to almost twice the average reduction prior to the last six recessions, when adjusted for inflation, according to Richard Berner, the chief U.S. economist at New York-based Morgan Stanley, another primary dealer. The firm expects the Fed to cut the rate to 3 percent in the third quarter. In the fourth, it will be raising it as the economy strengthens, he said.
TED Spread
When the Fed began lowering rates in September, the difference between the yield on three-month Treasury bills and the rate on dollar-denominated loans in London, an indication of credit risk known as the TED spread, had expanded to 1.6 percentage points from an average of 0.39 percentage point in the first half of the year.
The spread had narrowed to 1.12 percentage points before today's rate cut, showing banks are less wary of lending to each other.
``If you look at the money-market instruments and look at what's going on with the TED spread, that's reflecting some of the actions the Fed has taken,'' said Andrew Harding, who helps manage $18 billion as chief investment officer for fixed income at Allegiant Asset Management in Cleveland. ``They're effective.''
To contact the reporters on this story: Daniel Kruger in New York at dkruger1@bloomberg.net ; Sandra Hernandez in New York at shernandez4@bloomberg.net
Last Updated: January 22, 2008 11:16 EST
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