Zero Percent on Treasury Bills as China, Fed Policies Converge

The last time U.S. Treasury bill rates headed toward zero percent investors were panicking. Now it’s an indication Federal Reserve Chairman Ben S. Bernanke’s efforts to revive credit markets are starting to work.

Rates on three-month bills turned negative in December for the first time since the government began selling them in 1929 as investors sacrificed returns to preserve principal. After increasing at the start of the year, rates have dropped 0.20 percentage point since the beginning of February to 0.13 percent April 17.

Demand for bills is rising again because investors including foreign central banks are snapping up the shortest- term U.S. securities as the Federal Reserve buys Treasuries to drive down borrowing costs in a policy of so-called quantitative easing. China, the largest U.S. creditor, with $744 billion of debt, has questioned the practice and shifted purchases to bills from longer-maturity securities.

“There’s a group of investors out there who are looking at what the Fed is doing and the policy action they’ve taken and the asset purchases, and saying ultimately this is inflationary,” said Stuart Spodek, co-head of U.S. bonds in New York at BlackRock Inc., which manages $483 billion in debt. “You’re going to invest in very short-term bills because you absolutely need not just the quality but also the absolute liquidity.”

China bought $5.6 billion in bills and sold $964 million in U.S. notes and bonds in February, according to Treasury data released April 15. It was first time since November that China purchased more bills than longer-maturity debt.

Super Sovereign

Leaders in the second largest U.S. trading partner started voicing concern about their investments as Fed and Treasury officials pledged $12.8 trillion, the equivalent of 90 percent of last year’s gross domestic product, to pull the economy out of the worst recession in a generation.

People’s Bank of China Governor Zhou Xiaochuan called for the establishment of a “super-sovereign reserve currency” last month after Chinese Premier Wen Jiabao said he’s “worried” a weaker U.S. dollar may hurt China’s investments. Inflation and a depreciating dollar would erode the value of U.S. holdings owned by international investors.

At the same time, China added to its holdings. While Treasury depends on China to fund the deficit, exports account for about 40 percent of gross domestic product for the world’s most populous nation. China’s exports to the U.S. jumped 40 percent in March after slumping for five consecutive months.

‘Symbiotic Relationship’

Treasury Secretary Timothy Geithner refrained from labeling China as a currency manipulator last week, backtracking from an assertion he made during his confirmation hearings in January. In its first semiannual report on foreign-exchange policies since Geithner became secretary, the Treasury said April 16 that while China’s yuan remains “undervalued,” no country “met the standards” for illegal currency manipulation during the period of the report, from July 2008 through December 2008.

“China and the U.S. have a symbiotic relationship,” said Win Thin, a senior currency strategist in New York at Brown Brothers Harriman & Co. “We need each other.”

Treasuries lost 2.6 percent this year, according to Merrill Lynch & Co.’s U.S. Treasury Master Index, as the government increased bond sales to finance a federal budget deficit that President Barack Obama’s administration says may expand to $1.75 trillion.

The yield on the benchmark 10-year note rose three basis points last week, or 0.03 percentage point, to 2.95 percent, according to BGCantor Market Data. The 2.75 percent security due in February 2019 fell 7/32, or $2.19 per $1,000 face amount, to 98 9/32.

Below Zero

Three-month bill rates dropped five basis points last week to 0.13 percent. Bills maturing in three months and less have returned 0.07 percent this year, Merrill index data shows.

In December, bill rates fell below zero as investors sought the protection of the safest government debt in the wake of the September collapse of New York-based Lehman Brothers Holdings Inc., the biggest bankruptcy in history.

Treasury sold $27 billion of three-month bills on Dec. 8 at a discount rate of 0.005 percent, the lowest on record. The U.S. also sold $30 billion of four-week bills at zero percent for the first time. U.S. government debt of all maturities returned 14 percent last year, the best since 1995.

Foreign Holdings

Foreign investors including central banks own $3.16 trillion, or 50 percent, of the $6.27 trillion in marketable Treasuries outstanding, according to Treasury data. The U.S. needs to raise $3.25 trillion this fiscal year, as the government finances bank bailouts, stimulates the economy and services deficits, according to Goldman Sachs Group Inc.

“The Fed made the dramatic announcement in March that it’s going to monetize some of that deficit,” said Richard Clarida, a global strategic adviser at Pacific Investment Management Co. and Columbia University economist, raising concern that the purchases may lead to faster inflation. “The difference in migrating to bills versus bonds is their exposure to interest rate movements. You’re taking less interest rate risk.”

The Labor Department said April 15 that the consumer price index fell 0.4 percent in March from a year before, the first annual decline since 1955. The drop provides Bernanke with more time to narrow the difference between what consumers pay to borrow and the costs for banks, following the Fed’s decision in December to lower its target rate for overnight loans between banks to a range of zero to 0.25 percent.

‘Better Tone’

Consumers and companies are starting to benefit. Goldman Sachs and JPMorgan Chase & Co. reported higher-than-estimated profits last week, in part because of higher revenue from fixed- income markets. Both raised capital last week without government backing.

“The credit markets are achieving a better tone and getting stronger,” Dallas Federal Reserve President Richard Fisher said at a briefing in Shanghai on April 18. “Volatility has been dampened. It will take some time to correct the weakness we’re experiencing.”

Home mortgage rates have fallen to record lows, and borrowing costs for car loans have declined more than five percentage points since the Fed said March 18 that it would buy $300 billion of Treasuries to keep borrowing costs down, and raise its commitment to purchase mortgages to $1.25 billion.

The difference between the average 30-year U.S. mortgage rate and 10-year Treasury yields narrowed to 1.92 percent on April 17 from 3.07 percent on Dec. 19, the highest level since 1986, according to Bloomberg data. The gap averaged 1.75 percentage points in the decade before the credit crisis began.

“The bigger story is investors climbing out of the bunker and starting to take risk again as some of the recent data suggests the U.S. economy” will begin to recover, said Colin Lundgren, who manages $40 billion as head of institutional fixed income for RiverSource Institutional Advisors in Minneapolis.