By Jesse Hou, Boston University
In Buffet We Trust
On Wednesday, March 24, 2010 Berkshire Hathaway two year corporate bond yields dipped below that of comparable treasuries (by about 3.5 basis points), implying that investors at large feel Warren Buffet is a better credit risk than the United States government. Other brand name bonds for companies like Johnson & Johnson, Lowe’s, Abbott Laboratories, and Procter & Gamble also dipped below treasury yields. All of these companies except Procter and Gamble are rated lower than the US Government (AAA) which is contradicted by their respective yields.
The Auction Leading Up
Treasuries took an enormous hit during a $42 billion auction of five year notes Wednesday. A separate$44 billion auction Tuesday also experienced lower demand than usual, and another auction Thursday ended a record-tying $118 billion week of sales. The bid to cover ratio fell to 2.55, from 2.8 in January (Associated Press). Five year yields rose to 2.59% from 2.42% as a result. Across the board from 3 month to 30 year treasury yields rose sharply. The 10-year surged up 30 basis points.
All this coincided with the passing of a landmark healthcare bill that has generated $940 billion of additional health care spending over the next decade. Sovereign debt around the world has come under fire especially in the euro zone, and municipal debt in the United States is taking its worst beating in decades as California struggles with its seemingly inflexible budgeting system.
A Bloomberg survey of 10 to 18 primary dealers has $2.4 trillion as the median estimate for the estimated volume of treasuries to be auctioned this year.
What it Means for the Market
With continued deficits on the near horizon, and a guarantee that the so called “landslide” of treasuries ($2.59 trillion have been auctioned since 2009) will continue unabated, yields continued rising proving that the market cannot absorb an infinite amount of treasuries. (Marketwatch)
In general this macroeconomic phenomena is a sign that the market is starting to react adversely to the government fiscal policy, and may add fuel to the fires of rumor that the US Government may lose its AAA rating, something long denied by the government as an outrageous idea.
China has been cutting its holdings of US debt for three months in a row, now the second largets debt holder to Japan. The People’s Republic shows no sign of slowing this trend. The euro fell to 1.33 against the dollar, its lowest point in 10 months after Fitch cut the rating on Portuguese debt yet again this time to AA-. All of this activity caused confusion in the swaps market, as spreads turned negative last week for 10-year swaps, a technical fluke.
Buffet’s Opinion of US Treasuries
Warren Buffet stated in an interview that “with the US Federal Reserve and the Treasury Department going all in to jump-start an economy shrinking at the fastest pace since 1982, once-unthinkable dosages of stimulus will likely spur an onslaught of inflation, an enemy of fixed-income investors”. He strongly doubts the US will retain its AAA rating, and notes that 7% of GDP in 2010 is going towards servicing the federal debt, which will rise to 11% in 2013. The Oracle of Omaha has advised shareholders in several of his famous letters not to invest in treasuries.
Select Sources:
http://www.businessinsider.com/what-it-looks-like-when-the-bond-market-vomits-2010-3
http://blogs.marketwatch.com/fundmastery/2010/03/22/in-buffetts-bonds-we-trust/
