Treasuries love affair endures after first loss since 2009

Real Yields

The greenback is forecast to appreciate against the nine other Group-of-10 currencies next year, extending the best annual gain since 2008. The dollar will appreciate 3.5% versus the yen and 7.3% against the euro in 2014, according to data compiled by Bloomberg.

With yields on 10-year Treasuries more than doubling since reaching a record-low 1.379% in July 2012 and economists anticipating yields will rise to 3.4% next year, some measures indicate U.S. debt has become relatively inexpensive.

Inflation, which erodes the value of fixed-income payments, has been subdued in the U.S., potentially bolstering demand for bonds. Adjusted for consumer price increases, yields on 10-year notes are now 1.8 percentage points higher than the 1.24% rate of annual inflation last month, the most since June 2010, data compiled by Bloomberg show. As recently as February, real yields were negative.

Versus government debt in Japan, which holds more Treasuries than any foreign nation except China, real yields for the 10-year notes are the highest since 1998.

Term Premium

Demand will depend on “whether the yield advantage and the stable currency continues to attract money into Treasuries,” Jim Vogel, an interest-rate strategist at FTN Financial in Memphis, Tennessee, said in a telephone interview. “I don’t see the story changing that much that would drive people away.”

Based on its term premium, a valuation model used by the Fed that is calculated by using interest-rate expectations, economic growth and inflation, the 10-year note is the cheapest in more than two years. The gauge, which rises as a security becomes less expensive, climbed to 0.62% last week.

The gauge has averaged 0.21 in the past decade and was negative as recently as June 18, when the 10-year note yielded 2.19%, data compiled by Bloomberg show.

“These rate levels are more attractive than we’ve seen since 2011,” William O’Donnell, head U.S. government bond strategist at RBS Securities Inc., one of the primary dealers that trade with the Fed, said in a Dec. 27 telephone interview from in Stamford, Connecticut. That will drive demand and “temper any back-up from here.”

Direct Bidders

The decline in bidding at government bond auctions this year was led by the primary dealers needing to comply with Dodd- Frank financial reforms and Basel III banking regulations, as well as greater competition from direct bidders.

Dealers accounted for 46% of sales, the lowest since 2010, down from 49.7% last year.

Investors who aren’t primary dealers that placed bids directly with the Treasury bought a record 17.7% of the government securities this year, exceeding the previous all-time high of 14.4% last year. Indirect bidders, an investor class that includes foreign central banks, accounted for 36.3% of sales at auctions this year from 35.9% last year, Treasury data compiled by Bloomberg show.

“We still like Treasuries” and are buying them when yields rise, Sean Simko, who oversees $8 billion at SEI Investments Co. in Oaks, Pennsylvania, said in a Dec. 20 telephone interview. “You have the opportunity to selectively pick your points and add on to positions.”

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