April 23 (Bloomberg) -- Lacy Hunt, whose bond fund has beaten 99% of its peers during the past five years by buying the longest maturity Treasuries, says 30-year government securities remain the world’s best debt investment.
“The long end of the Treasury curve offers the greatest value,” Hunt, the chief economist at Austin, Texas-based Hoisington Investment Management, which oversees more than $4.5 billion, said April 17 in a telephone interview. “The risk of deflation is greater than the risk of inflation over the next several years,” said Hunt, whose firm’s Wasatch-Hoisington U.S. Treasury Fund has returned 76% since April 2007.
While the U.S. economy is expanding, it isn’t sparking faster inflation, helping push bond yields and government borrowing costs back toward record lows following the worst selloff since 2010 during the first quarter. After losing 7.6% in January through March as consumer confidence, retail sales and jobs gained, the 30-year Treasury has returned 4.4% in April.
Falling yields on longer-maturity fixed-income securities signal renewed confidence in the ability of Federal Reserve Chairman Ben S. Bernanke to keep consumer prices in check even as the economy grows.
Real Yields
Inflation concerns are abating even after the Fed pumped $2.3 trillion into the financial system by purchasing bonds in a policy known as quantitative easing, or QE, and kept benchmark interest rates near zero since December 2008. Thirty-year bonds have the added benefit of paying a yield that is higher than the rate of inflation, unlike notes due in 10 years or less.
In the first quarter, “you had concern of the Fed providing too much lighter fuel on the barbecue for too long,” Jim Hannan, a senior money manager in Baltimore at Wilmington Trust Investment Advisors Inc., which oversees about $25 billion in fixed-income assets, said April 18 in a telephone interview.
Confidence in the Fed is also seen in the difference between 10- and 30-year Treasury yields, which is little changed since the central bank raised its assessment of the economy on March 13. That spread, at about 1.16 percentage points, typically widens as investors demand higher yields on longer maturity debt when they expect faster growth to spark inflation.
“All of a sudden the 30-year looks a little bit better,” Hannan said.
Falling Yields
After falling from the high this year of 3.49% on March 19, yields on 30-year Treasuries were little changed last week at 3.13 percent, according to Bloomberg Bond Trader prices. The yield was 3.08% at 8:48 a.m. New York time. The benchmark 3.125% bond due February 2042 rose 29/32, or $9.06 per $1,000 face value, to 100 28/32.
A year ago, the yield was almost 4.5 percent. It has averaged 7.19% since 1980 and compares with a trailing 12-month inflation rate of 2.7 percent.
The long bond served as a benchmark for governments and companies from when the Treasury began regular sales of the debt in 1977 until 2001, when then-Undersecretary for Domestic Finance Peter Fisher suspended auctions, saying they were too costly. Investors turned to the 10-year note as the market benchmark.
Expanding budget deficits led Treasury officials to resume 30-year sales in 2006. Offerings increased as the financial crisis worsened and tax receipts plummeted, causing the shortfall to reach $1.42 trillion in 2009.
Last quarter’s slump may just be a preview of what’s to come, according to John Hendrick, senior vice president of global inflation-linked assets in Hartford, Connecticut, at Hartford Investment Asset Management, which oversees $165 billion.
“Long-run inflation will definitely rise at some point,” Hendrick said April 19 in a telephone interview. “It won’t take much of an increase in interest rates for investors to have significant capital losses.”
Warren Buffett, the billionaire chairman of Berkshire Hathaway Inc., said in his annual letter to shareholders that bonds and other holdings tied to currencies “are among the most dangerous of assets.”
Leon Cooperman, founder of equity hedge fund Omega Advisors Inc., said Feb. 22 in an interview on Bloomberg Television’s “InsideTrack” with Erik Schatzker that buying Treasuries is the least attractive investment and the worst place to put money for the next three years.
Yield Forecasts
Yields will likely rise to 4% by the third quarter of 2013, according to the median estimate of almost 50 economists and strategist surveyed by Bloomberg News. If that happens, investors stand to lose $70 million on every $1 billion of 3.125% Treasuries due in February 2042.
The U.S. sold $16 billion in five-year Treasury Inflation Protected Securities on April 19 at a record low negative yield of minus 1.08% as investors sought a hedge against the threat of rising consumer prices.
For Gary Pollack, head of fixed-income trading in New York at Deutsche Bank AG’s private wealth management unit, which oversees $12 billion in bonds, demand may be more of a reflection of Fed purchases than confidence in lower inflation. The central bank has been replacing $400 billion of shorter- dated maturities in its holdings with longer-term debt to contain borrowing costs. The strategy, dubbed Operation Twist by traders, is due to end in June.
‘Constant Buyer’
“The Fed has been a constant buyer every week and that has been a big supporter of long-term interest and has caused the curve to flatten,” Pollack said April 18 in a telephone interview in reference to the difference between short- and long-term yields. “The Fed is a big part of it.”
With the Fed reiterating last month that it expects to keep rates in a range of zero to 0.25% through 2014, a selloff in bonds is remote, according to bulls. Central bank members meet this week to discuss monetary policy.
Inflation as measured by the personal consumption expenditures index, excluding food and fuel, the gauge used by the Fed in its forecasts, rose 1.9% in February from a year earlier. That compares with more than 2.5% as recently as 2008.
The five-year, five-year forward breakeven rate, a bond market gauge used by the Fed to forecast inflation expectations starting five years from now, is coming down. It fell to 2.6% this month from last year’s high of 3.23% in August. The measure has averaged 2.76% the past decade.
Hoisington told clients in a first-quarter report that sustained inflation is unlikely after real median household income fell 5% in the decade ending in 2009 and probably declined to the lowest level last year since 1995.
High levels of household and government debt will continue to curb growth, Hoisington said. U.S. private and public debt to gross-domestic-product ratio is about 174 percentage points higher than the average since 1870, the firm said, citing Bureau of Economic Analysis, Fed and Census Bureau data.
“We lived beyond our means,” Hunt said. “To correct, you’re going to need a period of living inside your means,” which will curb growth, he said. “We’re looking for the long rates to go down from where they are.”
The $241.5 million Wasatch-Hoisington fund has gained 12% on average the past five years, topping the 6.4% gain for the benchmark Barclays U.S. Aggregate Total Return Index and better than 99% of its peers, data compiled by Bloomberg show. The fund has bought longer-maturity Treasuries since 1996, with bonds due May 2030 its largest holding.
Wage Gains
While the median estimate of 68 economists surveyed by Bloomberg is for the Commerce Department to say this week that gross domestic product expanded 2.5% last quarter, wage growth isn’t keeping up.
Average hourly earnings have risen 1.9% on average since the start of 2010, down from 2.7% in 2009, 3.2% in 2008 and 3.5% in 2007, according to Labor Department data released April 6.
Tame inflation contributed to a 35.5% return, including reinvested interest, in the 30-year Treasury bond in 2011 as measured Bank of America Merrill Lynch indexes. That’s the best year for the long bond after the 41.2% gain in 2008 amid the worst financial crisis since the Great Depression. About $675 billion of marketable coupon securities yield more than inflation, Treasury data show.
The 30-year Treasury is a proxy for inflation “over a long period of the time,” said Hunt, 69, who was chief U.S. economist for HSBC Group and senior economist at the Federal Reserve Bank of Dallas before joining Hoisington in 1996. “That’s where the economic fundamentals are most dominant,” he said. “It conveys a lot of information about economic conditions.”
