U.S. bonds cheapest since ’90 versus bunds counter Buffett

Bond Overreaction

Three Federal Reserve regional bank presidents, Richard Fischer of Dallas, Charles Plosser of Philadelphia and Jeffrey Lacker of Richmond, called last week for the central bank to phase out the $40 billion monthly purchases of mortgage-backed securities. It’s also buying $45 billion of Treasuries a month.

“The market has overreacted to the tapering signals from a Fed that is still on hold for some time, and inflation fundamentals globally and domestically are still weak,” Michael Pond, head of global inflation-linked research in New York at Barclays Plc, said in a phone interview on May 15. Treasuries are “attractive on a relative basis,” he said.

Gross domestic product may grow by 2% in 2013, down from 2.2% last year and the 2.7% posted in 2006 before recession and worst financial crisis since the Great depression, according to the median estimate of more than 80 economists surveyed by Bloomberg.

Growth globally is also depressed, with Japan forecast to expand 1.4% the euro region to contract 0.5%, according to separate Bloomberg surveys of economists.

Auction Demand

Evidence of bond demand can also be seen in the government’s debt auctions. The Treasury’s $777 billion in bond sales this year have attracted an average of $3 in orders per dollar sold, making this the third-strongest year ever and compared with the record $3.15 in 2012, according to data released by the Treasury and compiled by Bloomberg.

“It doesn’t look like a great big bond market selloff is coming anytime soon,” Jack McIntyre, a money manager who oversees $44.5 billion for Brandywine Global Investment Management LLC in Philadelphia, said in a May 16 telephone interview. “At the end of the day growth is still mixed, inflation is fairly tame and the Fed’s foot is still on the easing pedal.”

Treasury returns are enhanced by the slowdown in inflation. The consumer price index in the U.S. fell 0.4% in April following a 0.2% decrease in March, the first back-to- back declines since 2008, according to the Labor Department.

Falling commodity prices are weighing on inflation. The Standard & Poor’s GSCI Total Return Index of 24 raw materials has declined 8.6% from this year’s peak in February.

For international investors, a rising dollar also has the potential to boost returns from Treasuries. For yen based investors, this year’s losses in U.S. bonds would translate into a gain of 18.7% after currency conversions.

IntercontinentalExchange Inc.’s U.S. Dollar Index rose to 84.371 on May 17, the highest level since July 2010.

“A stronger dollar weighs on commodity prices and thus inflation,” said Richard Gilhooly, an interest-rate strategist at TD Securities Inc. in New York. “What is negative for inflation is a positive for Treasuries, especially given the U.S. real yield differential against everyone else.”

Bloomberg News

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