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... central banks ... are showing a growing preference for debt sold by government- sponsored companies such as Fannie Mae and Freddie Mac."
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bazaarmodel.net]
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Central Banks Favor U.S. Agency Debt Over TreasuriesBy Michael McDonald
September 4, 2006 - (Update1)
SourceSept. 4 (Bloomberg) -- The central banks that own one quarter of the $4.3 trillion U.S. government bond market are showing a growing preference for debt sold by government- sponsored companies such as Fannie Mae and Freddie Mac.
Central banks from Romania to South Korea have bought almost $116 billion of so-called agency debt this year, more than two-and-a-half times the $44 billion of Treasuries they've purchased, according to Federal Reserve data.
The shift to agency bonds, which offer on average an extra 0.3 percentage point in yield, may temper a rally in Treasuries that has pushed yields to five-month lows. Washington, D.C.- based Fannie Mae and Mclean, Virginia-based Freddie Mac sell the bonds mainly to support home lending.
``Many institutions have decided they need to have their assets work harder for them,'' said Jack Malvey, chief global fixed-income strategist at Lehman Brothers Holdings Inc. in New York. ``They are going to continue to buy agencies.''
Central banks are diversifying their assets at a faster rate. They bought about $14 billion in agency debt on average every month this year, up from $12 billion in 2005. The banks now hold $535 billion in agency securities, Fed data show.
U.S. two-year Treasury note yields would be as much as 0.2 percentage point lower if central banks weren't buying agency debt, said Dominic Konstam, global head of interest-rate products at Credit Suisse Securities USA in New York.
Treasuries Rally
Treasuries have rallied since June on speculation the Fed has finished raising the overnight interest rate on loans between banks, or federal funds rate. Two-year yields fell to 4.76 percent on Sept. 1, the lowest since March as investors such as Bill Gross, who manages the world's largest bond fund for Pacific Investment Management Co., turned bullish.
Markets in the U.S. are closed today for the Labor Day holiday. The Bond Market Association, which represents firms that underwrite, trade and sell debt securities, recommended a trading close.
Central banks' portfolios of U.S. bonds have swelled as their foreign currency reserves soared. China's record trade surplus with the U.S. has given it the world's largest reserves, approaching $1 trillion.
International currency reserves have increased 16.4 percent this year, to $4.57 trillion, according to central banks and the International Monetary Fund. China, Japan, Taiwan and Russia have the most, together accounting for 50 percent of the total.
The banks boosted Treasury holdings by an annual average of 20 percent in the three years through 2004. The purchases lowered U.S. 10-year note yields by about 1.5 percentage points, according to a Fed-commissioned study in September 2005.
Higher Yields
Demand for Treasuries has since cooled. Holdings rose $37.5 billion in 2005, or about 3.5 percent, Fed statistics show. Central banks owned $1.14 trillion of Treasuries as of Aug. 30, a 4.5 percent increase this year.
Agencies are luring central banks because they carry the highest ratings from Moody's Investors Service and Standard & Poor's while offering more yield. The average premium over similar-maturity Treasuries is about 30 basis points, according to data compiled by Merrill Lynch & Co. The yield difference was about 60 basis points at the end of 2000.
``We have been increasingly diversifying our portfolio,'' Bank Negara Malaysia Governor Zeti Akhtar Aziz told reporters in Kuala Lumpur on Aug. 30. ``We reduced our risks by being highly diversified,'' she said, declining to comment specifically on Malaysia's $78.3 billion of reserves.
Norway, Romania
Norway's central bank has increased its holdings of agency debt almost fivefold since 2003, to 8.2 billion kroner ($1.3 billion) at the end of 2005. Treasury holdings fell 5.1 percent to 18.8 billion kroner in the same period, the Oslo-based bank's figures show.
A spokeswoman for Norges Bank declined to comment when reached last week.
Romania, with $23.4 billion in reserves, has 8 percent in agencies and 25 percent in Treasuries, according to Cristian Muntean, head of foreign reserves management at the National Bank of Romania in Bucharest.
International investors including central banks have also bought fewer Treasuries at auction. The group purchased on average 29 percent of the securities sold at two-year auctions this year, down from 35 percent last year, government data show.
Speculation the Fed is finished raising rates may attract some international investors back to government debt. The central bank lifted its benchmark a 17th straight time on June 29, to 5.25 percent, then left it unchanged on Aug. 8.
Korea Buys
``We bought a lot'' of Treasuries in recent weeks while purchasing ``some'' agencies, said Yoon Yong-Jin, head of the Bank of Korea's treasury portfolio management group. ``Interest rates have approached a peak,'' he said in a telephone interview from Seoul last week.
Yoon said on Jan. 19 that the bank was diversifying from Treasuries into agency debt and securities with top credit ratings. South Korean investors held $68.9 billion of Treasuries as of June 30, down $4 billion from February. The country has $225.7 billion in reserves.
The European Central Bank, the central banks of England, the Philippines, Sweden and Taiwan, and the Monetary Authorities of both Hong Kong and Singapore declined to provide details on their holdings. Central banks typically don't discuss investment strategies because of the potential to move market prices.
Agencies have returned 2.4 percent to investors, including reinvested interest, beating the 1.5 percent gain on Treasuries this year, Merrill figures show.
Great Depression
Fannie Mae was created in 1938 during the Great Depression by President Franklin D. Roosevelt as part of an effort to bolster the economy by injecting money into the housing market. Congress set up Freddie Mac in 1970. The companies buy mortgages from financial institutions, enabling banks to make more loans. Their government charters have helped Fannie Mae and Freddie Mac borrow at lower rates than competitors.
Fannie Mae and Freddie Mac, the Federal Home Loan Bank System, Tennessee Valley Authority and Farm Credit System have about $2.7 trillion in debt outstanding, Bond Market Association data show.
``Investments in U.S. agencies are made in order to increment the income and to benefit from the diversification effect,'' said Romania's Muntean in an e-mailed response to questions.
To contact the reporter on this story: Michael McDonald in New York at
mmcdonald10@bloomberg.net .
Last Updated: September 4, 2006