Vanguard Group Inc., whose $148.2 billion of Treasuries makes it the largest private owner ofU.S. debt, says the nation has until 2016 to contain its borrowings before bond investors revolt and drive up interest rates.
“In the absence of a long-term credible plan, we are somewhere around four years away on where the markets are going to say ‘enough is enough,’” said Robert Auwaerter, head of theValley Forge, Pennsylvania-based Vanguard’s fixed-income group since 2003 and who this year was inducted into the Fixed Income Analysts Society Inc.’s Hall of Fame.
The U.S. has avoided the turmoil rocking Europe, where five nations have sought bailouts as their borrowing costs soared because investors boycotted their bonds. Instead, they have sought U.S. assets as a haven due to the dollar’s status as the world’s primary reserve currency, pushing note yields to record lows even though the amount of public debt outstanding has grown to $15.9 trillion from less than $9 trillion in 2007.
Demand for U.S. bonds and the dollar has bolstered PresidentBarack Obama’s ability to fund a budget deficit forecast to exceed $1 trillion for a fourth straight year, and helped Federal Reserve Chairman Ben S. Bernanke’s efforts to keep borrowing cost low. The greenback makes up 62.2 percent of all currency reserves, compared with 24.9 percent for the euro, according to the International Monetary Fund in Washington.
‘Little Upside’
Even with record-low yields, Treasuries maturing in 10 years or more have returned 7.4 percent this year, including reinvested interest. The Standard & Poor’s 500 Index (SPX) of stocks has gained 9.1 percent, including dividends, and commodities as measured by the S&P GSCI Index have lost 3.6 percent.
Investors aren’t getting paid enough for the risks of holding the debt, Elaine Stokes, a money manager at Loomis Sayles & Co., who helps oversee the $21 billion Loomis Sayles Bond Fund (LSBDX), said in a July 11 telephone interview.
“There’s very little upside, but there’s all kinds of downside,” Stokes said. “There’s a finite timeline to some of the issues that we’re facing. It’s no longer that we can keep kicking the can down the road,” she said in reference to lawmakers who keep raising the nation’s $16.4 trillion debt ceiling instead of reducing borrowing.
‘Difficult Markets’
“He’s been through a lot of difficult markets over those 30 years,” said Stephen Lessing, global head of senior relationship management in New York at Barclays Plc, a 32-year bond-market veteran who first met Auwaerter in 1981.
Congress will have to work with the winner of this year’s presidential election — Obama or presumptive Republican challenger Mitt Romney — to pass a plan within three to five years that puts the U.S. on a path toward sustainable budgets, Auwaerter said.
“With health care plus the demographics of the Baby Boom generation and the pressure that’s going to put on Social Security, all those things are going to come to a head over a three-to-five year time frame,” he said. “In a three- to five- year time frame the market can start to look at us like an Italy or Spain and start to assess a credit risk premium to U.S. Treasury yields.”
Marketable Debt
In Italy, whose more than $2 trillion of marketable debt outstanding ranks as third-most behind Japan and the U.S., yields on 10-year bonds have soared to more than 6 percent from less than 4 percent in October 2010. The spread to benchmark German bunds has widened to about 4.8 percentage points from about 1.5 percentage points in that period.
With taxes set to rise and spending cut by $1.2 trillion if Congress fails to agree by Dec. 31 on ways to reduce the deficit, the so-called fiscal cliff facing the U.S. might imperil an economy that is already slowing. The International Monetary Fund will this week cut its 3.5 percent estimate for global growth this year, Managing Director Christine Lagarde said July 12.
Goldman Sachs Group Inc. and Bank of America Corp., two of the 21 primary dealers of U.S. government securities that trade with the Fed, say the central bank will likely keep its benchmark rate at almost zero until mid-2015. Credit Suisse Group AG, another primary dealer, said in a report July 13 that 10-year yields will end next year at about 1.75 percent.
“The threats of what could drive rates higher have been out there for a long time and has not inhibited us from getting to this stage of the game,” David Ader, head of U.S. government bond strategy at CRT Capital Group LLC in Stamford, Connecticut, said in a telephone interview July 9. “The global economy is slowing and the dollar looks like the least pathetic thing and that’s going to keep bond flows coming in. This is where we are going to be: low rates for a long, long time.”
Bloomberg has the full article
