First Time in History - Direct Bidders Buy More Treasuries than Wall Street Dealers; Reflections on Common Sense

Here's an interesting sign of the times from Bloomberg: Treasury Bids Rise 18% as Investors Surpass Dealers

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 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.”

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.

Bond Bears

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.

Morgan Stanley of New York has lowered its estimate for the 10-year 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 survey is 3.36 percent, down from 3.80 percent in June.

Pent-Up Demand Takes Hold

Over the past few years I have received many taunts from people saying treasuries were a sure loser.

However, a few inquiring minds did ask who would buy them. My reply was there was a pent-up demand for treasuries. I said so in a rebuttal to Doug Kass on The Street.

Flashback Sunday, January 20, 2008: Time To Short Treasuries?

Kass Says Sell Bonds Short.

Kass: The bond market is in a bubble that is reminiscent of (and quite possibly as extreme as) other bubbles during previous eras. From my perch, the only issue is the timing of this trade.

Mish: Timing is indeed everything and perhaps there is a temporary selloff. But the primary trend is for lower yields. Perhaps much lower yields. There is no bubble in bonds. Not yet.

...

Furthermore, the pent up demand for treasuries in the US is enormous. They are despised by nearly everyone here. This internal pent up demand can easily pick up any slack from reduced purchases by foreigners. 2.5% yields may looks measly, but not vs. 15% declines in the stock market. 30%? 50%? Most are severely underestimating the potential for enormous stock market declines here.

Virtually no one, including Bernake thinks deflation can happen in the US. My position is that Things That "Can't" Happen are about to. The result will be Deflation American Style.

Anyone who wants to short treasuries with impunity on this economic backdrop can be my guest.

There is no bubble in treasuries if you look closely at the fundamental issues. Those who want to see how low treasury yields can get and stay there, need to look at Japan. Yields in the US are going to go far lower and stay lower longer than nearly everyone thinks.

Yields are much lower now, yet I see no reason to change my stance. By the way, I did issue an opposite warning in January 2009.

Tuesday, January 06, 2009: Reflections On 2008, Themes For 2009

It is quite possible the lows in treasury yields are in. Unlike 2008 where I was constantly beating the drums for lower yields, 2009 could be different. Here are the facts: 3 month and 6 month yields hit 0% and the 10 year came close to hitting 2%. Could there be lower yields still? Yes, quite easily. Is it worth playing for other than as a hedge or part of an overall investment strategy? No.

The subsequent bounce in yields provided an ample opportunity to get back in..

Where To From Here?

Morgan Stanley's 5.5% prediction is quite the miss. Moreover a revision to 3.5% is quite a revision.

Yet, as always, the key question is "where to from here?"

The answer depends on the data but the backdrop for favorable economic news seems unlikely. Thus, even after that huge downward revision in yield estimates, Morgan Stanley is likely to be off on the high side in my estimation.

Lack of Faith in Common Sense

From where I sit, it appears that nearly everyone has too much faith in the Fed's ability to reflate and too little faith in common sense reasons why that's not likely to happen anytime soon.

One key point is that consumer attitudes towards borrowing and bank attitudes towards lending have changed. We have reached a Consumption Inflection Point - No One Wants Credit and consumer spending plans have plunged.

That is an enormous headwind for Bernanke to be fighting. With retiring boomers downsizing spending, kids out of college hundreds of thousands of dollars in debt, and a grim picture for jobs nearly everywhere, those expecting the Fed to pull a miracle out of its hat are simply asking too much.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
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