March 12 (Bloomberg) -- U.S. banks bought more government and related debt in the first two months of 2012 than they did in all of last year, an endorsement of Federal Reserve Chairman Ben S. Bernanke’s assessment of the economy that’s boosting demand for bonds even with yields near the lowest on record.
Commercial lenders purchased $78.2 billion of Treasuries and securities of agencies in January and February, compared with $62.6 billion in all of 2011, bringing their holdings to $1.78 trillion, Fed data show. Deposits exceeded loans by a record $1.63 trillion last month, up from $1.17 trillion in January 2011, providing scope to buy more bonds.
While the economy has expanded for eight straight quarters, unemployment at 8.3%, the scheduled end of the Bush-era tax cuts, a mandatory $1 trillion in federal budget cuts over 10 years and the presidential election campaign have made banks hesitant to accelerate lending. Instead of providing credit, they are exploiting the gap between the Fed’s target interest rate for overnight loans and Treasury yields to make profits.
“Bank managers are still very cautious, and that’s appropriate,” Jeffrey Caughron, a partner at Baker Group LP in Oklahoma City who advises community banks on investments of more than $30 billion, said in a March 6 telephone interview. “We don’t expect negative growth or a recession, but we expect sluggish growth. There’s not the kind of loan demand that banks are used to having, so banks have excess liquidity and the place to go is the bond market.”
Caughron advises clients to invest in government and municipal bonds.
Banks are buying more Treasuries even with yields on benchmark 10-year notes about 35 basis points above the record low of 1.67% on Sept. 23 because Bernanke has pledged to keep rates around zero through 2014. The difference between the federal funds rate and the yield on the 10-year Treasury was at 177 basis points, or 1.77%age points, today. In 2006 and 2007, yields were below the Fed’s key rate.
The benchmark 10-year yield fell one basis point, or 0.01%age point, to 2.02% at 10:30 a.m. London time, according to Bloomberg Bond Trader prices. The yield advanced five basis points last week, the most since the period ended Feb. 10.
Low yields will allow the U.S. to finance a fourth straight annual budget deficit of more than $1 trillion at a cost of 3.1% of gross domestic product, compared with 3.8% in 2000 and 4.1% in 1999, when the nation had budget surpluses, according to Office of Management and Budget and International Monetary Fund data compiled by Bloomberg.
Bond strategists forecast that yields will rise by the end of 2012, with the median estimate for the 10-year note at 2.47%. The benchmark government issue yielded an average of 4.9% for the past two decades.
“Treasury yields are going to remain lower than people think, frustratingly low for a while,” Eric Pellicciaro, head of global rates investment at New York-based BlackRock Inc., which manages $1.14 trillion in fixed-income assets, said in a March 7 telephone interview. “That’s a very good backdrop for fixed income.”
Pellicciaro said he is buying mortgage securities and recommends Treasuries when yields rise to between 2.25% to 2.5%. “Under two% is not a lot of value.”
Banks have increased holdings of government debt since 2008 to protect their capital after the credit crisis caused more than $2 trillion in writedowns and losses at global financial institutions, according to data compiled by Bloomberg.
The Fed’s low-rate policy “has been a plan to buy time for the banks to take free money and invest it, and make some kind of spread, and work their way out of the hole they were in,” said Mark MacQueen, a partner and money manager in Austin, Texas, at Sage Advisory Services Ltd., which oversees $10 billion, in a telephone interview on March 6. “Banks are trying to clean up and improve the appearance of their balance sheets and buying Treasuries accomplishes this.”
They have just as much reason to own Treasuries now after falling profits led banks and brokers to announce more than 50,000 job cuts in the past year, Bloomberg data show.
The average net interest margin at the four largest U.S. banks -- JPMorgan Chase & Co., Bank of America Corp., Citigroup Inc. and Wells Fargo & Co. -- shrank to 2.99% in the fourth quarter from 3.17% a year earlier. Net interest margin is a gauge of bank profitability based on the difference between the cost of funds and what they earn on assets.