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US starts to sell bonds with negative interest rates

27 October 2010 14:35 (UTC +04:00)

Baku â€“ APA-Economics. The abnormal state of the credit markets came into focus as the US Treasury sold bonds with negative interest rates for the first time and Goldman Sachs prepared to issue its first 50-year debt deal, Financial Times reported.
Both developments on Monday highlighted the difficult choices facing investors at a time when interest rates are at historical lows and the Federal Reserve is moving towards more asset purchases aimed at boosting the economy and staving off deflation. Investors who think the Fed will succeed in its efforts â€“ which would lead to higher inflation â€“ accepted a yield of minus 0.55 per cent on $10bn of Treasury inflation protected securities, or Tips, which compensate holders if the consumer price index rises.
At the same time, retail investors looking for higher yields in the current low interest-rate environment were targeted by Goldman, which prepared to sell $250m of 50-year bonds that are expected to pay interest of up to 6.25 per cent.
â€œThe Fed has been sending the message that its chequebook is ready and it will do what it takes to reflate the economy,â€ said Jan Loeys, head of global asset allocation at JPMorgan Chase. â€œWhat no one knows is whether inflation will start to show in two weeks or two years.â€
Mr Loeys added: â€œWe are seeing longer-term-thinking clients becoming increasingly wary of bonds and hedging against inflation. Shorter-term thinkers are still willing to buy bonds, on the presumption that they are nimble enough to get out when inflation comes to push yields up.â€
Long-term institutional buyers purchased 39 per cent of the $10bn Tips sale, up from an average share of 30 per cent for the previous six Tips sales.
The negative rate for Tips is a boon for the Treasury as it lowers its financing costs. But it may herald problems for bondholders in the future, because higher inflation would erode the value of fixed-income securities without inflation protection. Expectations for inflation during the next five years â€“ based on comparing Treasury yields and those for Tips â€“ have risen as high as 1.75 per cent this month, up from 1.13 per cent in August.
Analysts say they doubt that the current environment of low nominal Treasury yields and strong demand for Tips with negative rates can last. â€œIf inflation protection is in such strong demand that investors will buy aggressively at negative real yields, then surely at some point investors have to question the wisdom of buying nominal Treasuries with such low yields,â€ said Richard Gilhooly, strategist at TD Securities.