Uneasy Investors Sell Billions in Treasurys; Nervousness Over U.S. Debt Has Investors Unloading U.S. Bonds

Uneasy Investors Sell Billions in Treasurys

Nervousness Over U.S. Debt Has Investors Unloading U.S. Bonds

MIN ZENG

Oct. 14, 2013 8:30 p.m. ET

While leaders in Washington have been chasing a deal to avert a U.S. default, investors and banks have dumped billions of dollars in government debt. In the past two weeks, investors have sold mountains of short-term debt issued by the government. Banks have also reduced their holdings, trimming such debt by more than 50% over that period, according to data from the Federal Reserve Bank of New York. Amid anxiety about near-term finances, yields on U.S. debt that comes due in one month have risen to levels higher than for similar securities that don’t mature for six months. Typically, issuers pay more to borrow for longer periods of time.Some large institutions have taken steps to prevent clients from using short-term U.S. debt in certain transactions, to avoid being stuck with the debt in the event of a U.S. default.Citigroup Inc. C +0.77% has started telling some clients it would rather not take Treasurys maturing Oct. 24 or Oct. 31 as collateral, sounding out clients about whether they could instead use Treasurys that mature later, according to people familiar with the matter.

Units of Boston-based bank State Street Corp. STT +0.07% have been discussing which Treasury bills—or debt securities maturing in a year or less—it may restrict as collateral for loans and trades, according to a person familiar with the matter. A spokesman for State Street said the firm is “monitoring negotiations in Washington, and evaluating how we can protect our clients,” but had “not implemented any changes with respect to [its] collateral policy.”

Many market participants have also warned that tension about America’s financial soundness could mean the U.S. ultimately pays more to borrow money, which could ripple through to borrowing costs for American companies, cities, states and other entities. And some foreign leaders have complained publicly about U.S. officials letting the nation approach default.

“It is not about the inability of the U.S. to pay the bills,” said Kenneth Silliman, New York-based head of short-term rates trading at TD Securities Inc. “It is the political dysfunction that is the problem.”

Many money-market mutual funds—which lend cash day to day to banks—have unwound trades so they wouldn’t be stuck with too little money on hand in case markets took a turn for the worse.

“In the near-term, any budget agreement would be viewed as a positive,” said Russ Koesterich, global chief investment strategist at BlackRock Inc. BLK +0.63% “But if the best Washington can do is a series of short-term extensions, there will be an economic price to be paid.”

A potential short-term deal also wouldn’t eliminate the prospect of another cut to the U.S. credit rating, which raters have warned could be in order based on continued political instability and partisan wrangling. A lower rating could mean the government would pay more to borrow, and some investors may be forced to sell U.S. debt.

In August 2011, Standard & Poor’s Ratings Services downgraded the U.S. from its triple-A credit rating a few days after Congress reached a compromise to keep the country out of default. Then, S&P said “political brinkmanship” in Washington made the government’s ability to manage its finances less stable and effective. S&P has the U.S. sovereign rating on a stable outlook, meaning there is a less than one in three chance of another downgrade in the next two years.

Fitch Ratings is now sounding the alarm. It said last week it may downgrade the U.S. if the government doesn’t raise the federal debt ceiling in a “timely manner,” and it warned that a prolonged government shutdown would “damage perceptions of U.S. sovereign creditworthiness” and “signal that the U.S. government was in financial distress.” Fitch is the only major ratings firm with a negative outlook on the U.S. rating. It gives U.S. debt its highest rating, triple-A, as does the other of the three leading ratings firms, Moody’s Investors Service.

To be sure, even with the potential for higher rates and the specter of repeated political standoffs, U.S. Treasurys remain the go-to market for global investors when financial or economic troubles mount.

More than 60% of foreign-exchange reserves globally are denominated in the U.S. dollar, according to data from the International Monetary Fund. And the U.S. Treasury market, with a value of $11.6 trillion, is bigger than the sum of government bond markets in Germany and the U.K., two other nations whose debt is often seen as a safe harbor.

Recent Treasury-bond auctions suggest foreign demand remains solid. A sale of $21 billion in benchmark 10-year notes last Wednesday saw one measure of foreign investment, the so-called indirect bid, at 38.6%, higher than the 36.6% seen in the sale in September. The indirect bid for a sale of $13 billion in 30-year bonds Thursday was 41.9%, the highest since March, suggesting buyers of U.S. debt see any default as being short-lived.

Investors in the U.S. bond market didn’t have to come to work Monday in honor of Columbus Day, but if a deal is reached before markets open Tuesday, many expect the yields on short-term Treasury bonds to fall as the government auctions off more than $60 billion of new three-month and six-month debt. Banks and money-market funds may be able to put on hold contingency plans they had begun to implement, such as restricting clients’ ability to use short-term Treasury bills as collateral for loans, or tricking their computer systems to trade defaulted Treasurys.

Bond investors are wary of the potential for repeated stalemates. Some investors late last week were already selling short-term Treasury debt due in late November and December, expecting another showdown later this year if any deal postponed the debate.

“Euphoria would be short-lived” if Washington reaches a short-term solution, as concerns would shift toward the next debt-ceiling date, said Andrew Brenner, head of international fixed income at National Alliance Capital Markets in New York.

The one-month Treasury-bill yield closed last week at 0.254%, higher than the three-month T-bill, which was yielding 0.06%, and the six-month T-bill’s 0.076%. The T-bill due Dec. 19 yielded 0.19% at the end of last week. Bond yields rise when prices fall.

U.S. stock investors are likely to cheer a deal in Washington, though many had shown little concern about U.S. economic growth throughout the government shutdown.

“The quicker the government opens back up, and the longer the debt ceiling is extended, the better the rally,” said Alan Gayle, who oversees about $325 million as senior investment strategist at RidgeWorth Investments.

At its lowest closing point since the government shutdown began Oct. 1, the Dow Jones Industrial Average was down just 2.3% for the month. The blue chips finished Monday’s session up 1.1% since Sept. 30.

Nonetheless, stock investors around the world are pulling their money out of U.S. funds and looking to Europe and other regions to buy equities, said BlackRock’s Mr. Koesterich. He said this contrasts with the first half of the year, when investors were pouring cash into the U.S. markets.

Global equity mutual funds and exchange-traded funds took in $7.8 billion of cash in the first eight trading days of October, while U.S. equity mutual funds and ETFs redeemed $11.3 billion, according to data from TrimTabs Investment Research.