Treasuries Fall As Russia States They Want to Diversify Into IMF Bonds… Plus a Podcast From Kadarian on PPIP & Commercial Real Estate

Podcast with Kadarian

Russia causes some fear in the bond markets

By Dakin Campbell and Dan Kruger

June 10 (Bloomberg) — Treasuries fell, pushing 10-year yields to the highest level since November, as the government prepared to sell $19 billion in the securities and Russia said it may switch some of its reserves from U.S. debt.

Thirty-year bond yields touched the most in a year after the first deputy chairman of Russia’s central bank said the nation may buy International Monetary Fund bonds. The Federal Reserve began buying debt maturing in 2019 through 2026. Today’s auction is the second of three sales this week that will raise $65 billion, part of the U.S.’s record borrowing program.

“The Fed’s going to buy maybe $3 billion,” said Brian Edmonds, head of interest rates at Cantor Fitzgerald LP in New York, one of 16 primary dealers that trade with the Fed. “We’ve got $19 billion to bid on at 1 o’clock, and then we’ve got bonds following tomorrow. I think we’ll probably be under a lot of pressure.”

The yield on the 10-year note rose four basis points, or 0.04 percentage point, to 3.89 percent at 10:47 a.m. in New York, according to BGCantor Market Data. The 3.125 percent security maturing in May 2019 declined 10/32, or $3.13 per $1,000 face amount, to 93 23/32.

The 30-year bond yield rose four basis points to 4.69 percent. It earlier touched 4.73 percent, the highest in a year. The government is scheduled to sell $11 billion of the securities tomorrow.

Russia Switch

Russia’s central bank may switch some of its reserves from Treasuries to International Monetary Fund bonds, the bank’s first deputy chairman, Alexei Ulyukayev, said in Moscow today. His comments were confirmed by a bank official who declined to be named, citing bank policy.

Finance Minister Alexei Kudrin said last month that Russia planned to buy $10 billion of IMF bonds using money from its foreign reserves.

Russia holds $138.4 billion of U.S. debt. China is the largest U.S. creditor, with $767.9 billion. The U.S. government must rely on foreign investors to sustain record borrowing.

The dollar fell as Russia’s announcement added to speculation central banks around the world may try to diversify their reserves away from the U.S. currency. The Dollar Index, used by the ICE to track the greenback against the euro, yen, pound, Canadian dollar, Swiss franc and Swedish krona, decreased 0.2 percent to 79.649, after sliding 1.3 percent yesterday.

“The market is reacting to this Russia thing,” said Arthur Bass, a managing director of derivatives in New York at the brokerage Newedge USA LLC. “The dollar has restarted its dive to lower levels.”

Reserve Currency

While leaders of the nations of Brazil, Russia, India and China talk about substituting the dollar, the so-called BRIC countries have increased foreign reserves at the fastest pace since September. The nations added more than $60 billion in foreign reserves in May to limit currency gains, data compiled by central banks and strategists show.

Many of those reserves are still being plowed into U.S. debt securities, according to Fed data. The central bank’s holdings of Treasuries on behalf of central banks and institutions from China to Norway rose by $68.8 billion, or 3.3 percent, in May, the third most on record, data compiled by Bloomberg show.

The Treasury said bidding from foreigners was above average at its $35 billion three-year note auction yesterday. The sale drew bids for 2.82 times the amount of debt available, rising from 2.66 in May. Investors bought the notes after yields rose more than 50 basis points in less than a week.

“The market tends to need to build in fairly heavy concessions before every sale,” said Marc Ostwald, a strategist in London at Monument Securities Ltd. “It will be the same for today’s 10-year auction.”

Annual Loss

Longer maturities are leading losses in the Treasury market in 2009, indicating investors are demanding more yield because of the threat inflation will quicken in coming years.

Thirty-year bonds handed investors a 28 percent loss this year, versus 11 percent for 10-year notes and 0.4 percent for two-year securities, according to indexes compiled by Merrill Lynch & Co. Treasuries of all maturities have fallen 6.2 percent this year, according to Merrill indexes. The securities haven’t posted an annual decline since 1998, according to the index.

The Fed began buying Treasuries maturing between August 2019 and February 2026 today as part of the central bank’s $300 billion, six-month effort effort to reduce lending rates and lift the world’s largest economy out of recession.

Record Borrowing

President Barack Obama may borrow $3.25 trillion in the fiscal year ending Sept. 30, almost four times the $892 billion in 2008, according to primary dealer Goldman Sachs Group Inc. The budget deficit is projected to increase to $1.85 trillion in the year ending Sept. 30, equivalent to 13 percent of the nation’s economy, according to the nonpartisan Congressional Budget Office.

All told, the government and the central bank have spent, lent or committed $12.8 trillion, an amount that approaches the value of everything produced in the country last year, to stem the longest recession since the 1930s.

The difference between rates on 10-year notes and Treasury Inflation Protected Securities, which reflects the outlook among traders for consumer prices, was 2.04 percentage points, a nine- month high.

Today’s Highlights: ISLE, HD, NOH, & SEH

Pay close attention to ERTS

Other Stocks in play

May jobs report has a key tell

Henry Blodget|Jun. 10, 2009, 6:08 AM

Remember last week’s jobs report–the one that started the market buzzing about a V-shaped recovery? Well, according to Harvard economist Jeff Frankel, it wasn’t so great, after all.

Instead of focusing on changes in actual jobs to measure the strength of the labor market, Frankel focuses on “hours worked.” He does this because companies under pressure often reduce hours and overtime before they cut jobs. Similarly, when the economy turns up, companies often start adding hours and overtime before they start hiring. Thus, total hours worked provides a more real-time view of the state of the economy.

And how did total hours worked look in May? Lousy. Specifically, according to Frankel, they did not suggest any sort of a turn in the labor market.

Total hours worked is equal to the total number of workers employed multiplied by the average length of the workweek for the average worker. The length of the workweek tends to respond at turning points faster than does the number of jobs. When demand is slowing, firms tend to cut back on overtime, and then switch to part-time workers or in some cases cut workers back to partial workweeks, before they lay them off. Conversely, when demand is rising, firms tend to end furloughs, and if necessary ask workers to work overtime, before they hire new workers. (The hours worked measure improved in April 1991 and November 2001 which on other grounds were eventually declared to mark the ends of their respective recessions.) The phenomenon is called “labor hoarding” and it is attributable to the costs of finding, hiring and training new workers and the costs in terms of severance pay and morale when firing workers.

Unfortunately, as reported by Forbes, pursuing this logic leads to second thoughts about whether the most recent BLS announcement was really good news after all. The length of the average work week fell to its lowest since 1964 ! The graph below shows that, not only did total hours worked decline in May, but the rate of decline (0.7%) was very much in line with the rate of contraction that workers have experienced since September. Hours worked suggests that the hope-inspiring May moderation in the job loss series may have been a monthly aberration. If firms were really gearing up to start hiring workers once again, why would they now be cutting back as strongly as ever on the hours that they ask their existing employees to work? My bottom line: the labor market does not quite yet suggest that the economy has hit bottom.

Read Frankel’s full post here

Vehicle and factory production moves higher

June 10 (Bloomberg) — U.K. manufacturing rose for a second month in April as a rebound in motor vehicle production helped end the yearlong factory slump and temper Britain’s recession.

Output climbed 0.2 percent from March, when it increased by the same amount after being revised up from a drop, the Office for National Statistics said today in London. Economists predicted a 0.1 percent gain, according to the median of 26 forecasts in a Bloomberg News survey.

Bank of England Deputy Governor Paul Tucker said yesterday that confidence may be stabilizing, and other reports this month showed the housing market slump is moderating and service industries expanded for the first time in a year. This data suggests the recession may have slowed in the second quarter after the economy shrank the most since 1979.

“It’s encouraging that we’re seeing some improvement,” said Ross Walker, an economist at Royal Bank of Scotland Group Plc in London. “I’m still cautious about reading too much into this, but at least there’s a sense we’re through the worst.”

The pound extended gains on speculation the economy is emerging from recession. The U.K. currency climbed to $1.6420 at 10 a.m. in London, from $1.6305 yesterday. It strengthened to 86.07 pence per euro, from 86.27 pence.

Six categories of factory production fell and seven rose on the month, the statistics office said. The biggest gain was in transport on higher production of cars and other motor vehicles, followed by chemicals and manmade fibers, and paper and publishing output.

Transport Equipment

Transport equipment production is still down by 22 percent from a year earlier, officials said.

Johnson Matthey Plc, the producer of a third of all autocatalysts, said June 4 that it expects operating profit and revenue to slide in the fiscal first half as car sales stagnate. U.K. aerospace manufacturers face some “tough” years ahead as the recession limits airline traffic and governments reduce defense spending, their main trade association said today.

Still, “we’ve seen indications that world trade is beginning to find a bottom,” Kounis said. “The export sector also has advantage of a significant improvement in competitiveness because of the drop in sterling. When world trade does start to improve, the U.K. is well placed to benefit.

Exports rose 0.6 percent on the month, while imports increased by 2.6 percent, the statistics office said today. The trade deficit widened to 7 billion pounds ($11.5 billion).

Housing Market

The U.K. housing market showed signs of “stabilizing” in May, the Royal Institution of Chartered Surveyors said yesterday. Markit’s services index, based on a survey of purchasing managers, rose to 51.7 in May, indicating expansion for the first time in a year. Nationwide Building Society’s consumer confidence index also climbed.

Tucker still said that it won’t be clear if the economy’s is improving for a few more months, “until the autumn.” The International Monetary Fund predicts the biggest U.K. contraction since World War II this year.

The Bank of England kept the benchmark interest rate at 0.5 percent last week and reiterated its plan to spend 125 billion pounds in newly printed money in U.K. debt markets to help the economy. The bank said this week it may widen the range of assets it’s buying to include secured commercial paper.

China CPI data

By Bloomberg News

June 10 (Bloomberg) — China’s consumer prices fell for a fourth month, making it easier for the government to keep interest rates low and boost spending to revive the world’s third-largest economy.

Prices dropped 1.4 percent in May from a year earlier, after falling 1.5 percent in April, the statistics bureau said today. The median estimate in a Bloomberg News survey of 16 economists was for a 1.3 percent decline. Producer prices fell 7.2 percent, the most on record.

Inflation may return as the economy recovers and commodity prices climb from last year’s lows. The central bank triggered an explosion in credit this year by scrapping restrictions on growth in new loans and keeping the one-year lending rate at a four-year low of 5.31 percent.

“China’s economy is already rebounding and as soon as it regains momentum, prices will return to positive territory,” said Sherman Chan, an economist with Moody’s Economy.com in Sydney.

Australia’s consumer confidence
By Jacob Greber

June 10 (Bloomberg) — Australian consumer confidence jumped in June by the most in 22 years after the economy unexpectedly avoided a recession, stoking speculation the central bank has finished cutting interest rates.

The sentiment index rose 12.7 percent from May to 100.1 points, according to a Westpac Banking Corp. and Melbourne Institute survey of 1,200 consumers conducted between June 1 and June 7. It’s the first time since January 2008 that the index was above 100, indicating optimists outnumber pessimists.

Australia’s currency and stock index extended gains as the jump in confidence reinforced central bank Governor Glenn Stevens’ view the economic growth will begin accelerating later this year. Home-loan approvals rose for a seventh month as the lowest borrowing costs in 49 years and government handouts bolstered demand among first-time buyers, a report showed today.

“Today’s data add to the case for the Reserve Bank to remain on the sidelines,” said Michael Blythe, chief economist at Commonwealth Bank of Australia in Sydney. “A rebound in confidence is an essential precondition for economic recovery.”

Sentiment among Australian businesses jumped in May by the most in almost eight years after the government said it will spend A$22 billion on roads, railways, hospitals and schools, a National Australia Bank Ltd. survey showed yesterday.

Iron Ore that is

By Jesse Riseborough

June 10 (Bloomberg) — China is set to accelerate investment in iron ore projects in Australia, the world’s biggest exporter, after the collapse of its deal to buy stakes in mines owned by Rio Tinto Group.

“The opportunities for Chinese groups to come in and facilitate development of some of the smaller players are definitely going to start picking up pace,” said Eric Lilford, head of Australia mining at Deloitte Corporate Finance. Australia has A$26 billion ($21 billion) of proposed new iron ore mines, according to government estimates.

Rio last week scrapped a planned $19.5 billion deal with Aluminum Corp. of China, known as Chinalco, in favor of a share sale and iron ore venture with BHP Billiton Ltd., dashing Chinese expectations of locking in more supplies. Aurox Resources Ltd., Grange Resources Ltd. and Atlas Iron Ltd. may attract increased investment from China, according to Ord Minnett Ltd., an affiliate of JPMorgan Chase & Co.

“We won’t see this trend stopping or being deterred by Chinalco’s rejection because these companies are trying to get sustained supplies with stable prices,” said Zhou Xizeng, a Beijing-based analyst at Citic Securities Co. “Chinese companies have been successful in forming alliances with Australian junior miners.”

Fortescue Metals Group Ltd., Australia’s third-largest iron ore exporter, declined 2.2 percent to A$3.11 yesterday on the Australian stock exchange, paring its gain this year to 61 percent. Atlas rose 3.7 percent, Aurox advanced 4.6 percent and Grange increased 2.3 percent.

Billionaire Forrest

Fortescue, controlled by billionaire Andrew Forrest, may be a target of Chinese investment with Baoshan Iron & Steel Co. and China Minmetals Group among companies seeking acquisitions of overseas mining projects as the nation opens its purse strings, Citigroup Inc. said last month. China may spend more than $500 billion on overseas resources investments over the next eight years, according to Deloitte Touche Tohmatsu.

“It will refocus interest on the junior iron ore sector in the Pilbara” region of Western Australia, said Mike Young, managing director of Perth-based iron-ore explorer BC Iron Ltd. “The Chinese want to have a more personal level of involvement with their suppliers. The private mills in China will start looking at other players.”

Rio, BHP and Brazil’s Vale SA, the world’s biggest exporter, control about 75 percent of the global iron ore exports. Steelmakers in China, Europe and Japan have said the planned venture between Rio and BHP, the world’s second- and third- largest producers, would limit competition.

Monopoly Hints

The China Iron & Steel Association has rejected an agreement reached by Rio Tinto and Japanese and Korean mills for a 33 percent cut in annual contract prices, still at the second- highest level on record. The BHP-Rio venture “hints heavily of monopoly,” the Chinese group said in a statement yesterday.

China, the biggest buyer of iron ore, needs supplies to boost economic growth and the nation’s 4 trillion yuan ($585 billion) stimulus package has helped manufacturing expand, sparked record vehicle sales and boosted monthly imports of iron ore, copper and aluminum to records in April.

A total of 33 “less advanced” iron ore projects, with an estimated cost of A$26 billion, are planned, the Australian Bureau of Resources and Agricultural Economics said in a report last month.

Lower Grade

Many are lower-grade, magnetite ore projects including Aquila Resources Ltd.’s A$4.1 billion West Pilbara project and Atlas Iron’s A$3 billion Ridley project. Magnetite needs greater processing than higher-grade hematite ore, which accounts for about 96 percent of Australia’s output, according to Gindalbie Metals Ltd.

“The Chinese love magnetite so I’m sure they are going to push into the magnetite space big time,” Peter Arden, a resource analyst at Ord Minnett, said in an interview in Melbourne. “You are going to see at this stage multiple stakes being taken all over the place, to put their foot on it and keep others out.”

To be sure, China may also invest in projects outside of Australia, said Alan Heap, managing director of global commodities for Citigroup in Sydney. “There is high grade ore in West Africa, there is high grade ore in India,” he said.

Rio’s decision “aroused great repercussions among China’s enterprises and people,” Chinese foreign ministry’s spokesman Qin Gang said in an e-mailed statement yesterday. “However, we still believe China’s enterprises will continue” to carry out international investments and cooperation, he said.

The trend toward overseas investment “won’t be changed just because of one or two cases of failure,” said Li Kejie, a spokesman at Sinosteel Corp., China’s second-largest iron-ore trader, which last year acquired Australian producer Midwest Corp. for A$1.4 billion in cash.

Hunan Valin Iron & Steel Group, China’s ninth-largest steelmaker, this year bought a 17.3 percent stake in Fortescue for A$1.3 billion. Fortescue may need as much as $4 billion to proceed with plans to almost double output, Valin said last month.