By Theresa Barraclough Oct. 16 (Bloomberg) -- Treasuries are “relatively cheap” compared with European and Japanese government debt, as 10-year yields are likely to fall to April levels, according to RBS Securities Inc. Demand from domestic households and banks will support the Treasury market, helping push 10-year rates to 3 percent by year-end, said Brian Lancaster, head of asset-backed debt strategies at RBS Securities. Longer-dated bonds may outperform shorter-maturity notes on speculation the U.S. consumer price index has yet to reach bottom, he said. “Treasuries should remain an asset class of choice for global investors,” Lancaster said at a seminar in Tokyo yesterday. “Households and banks should return as ever-larger Treasury debt holders as bank lending stays constrained and as Boomers age and households save more.” Consumers lost $9.67 trillion of wealth last year as the housing bubble burst and the S&P 500 tumbled 38 percent, the most since 1937. The declines spurred households to increase the savings rate to 5.9 percent in May, the highest since 1998. The rate was 3 percent in August, above the three-year low of 0.8 percent reached in April 2008, Commerce Department data show. Relative Attraction U.S. debt handed investors a return of 6.2 percent over the past 12 months as of yesterday, according to Merrill Lynch & Co.’s Treasury Master Index. German bund holders received a 9.5 percent increase and Japanese government bonds delivered a 3.7 percent gain. The yield on the 10-year note stood at 3.46 percent at 7:40 a.m. in Tokyo, according to BGCantor Market Data. The 3.625 percent debt due August 2019 was trading at 101 10/32. Should Treasury yields fall to 3 percent by Dec. 31 as Lancaster predicts, investors who buy the debt today would make a return of 4.5 percent, Bloomberg calculations show. Analysts and economists in a weighted Bloomberg survey say German 10-year yields are likely to increase to 3.43 percent from 3.30 percent now and Japanese yields will climb to 1.35 percent from 1.32 percent in the same period, incurring losses for investors. The rate on Treasuries will be little changed at 3.48 percent. Ten-year Treasuries have a yield premium of 0.18 percentage point over similar-dated German bunds and 2.13 points over Japanese debt, making the U.S. securities “relatively cheap,” Lancaster said. Investors are adding to their Treasuries holdings amid concern about a sluggish U.S. recovery, including Bill Gross, who runs the world’s biggest bond fund at Pacific Investment Management Co. Gross bought government debt last month and cut mortgage bond holdings to the lowest level since 2005. Gross boosted the $185.7 billion Total Return Fund’s investment in Treasuries, so-called agency debt and other government-linked bonds to 48 percent of assets in September from 44 percent in August, according to Pimco’s Web site. The government holdings are the most since August 2004. ‘Subdued Inflation’ “Inflation is likely to remain subdued,” Lancaster said. “We’re on the cusp of a sustained bull-flattening,” he said referring to when yields on longer-dated bonds fall at a faster pace than rates on shorter-maturity notes. The yield differential between two- and 10-year debt expanded to 2.52 percentage points today, near the widest since Sept. 15. The gap is likely to narrow to 2 percentage points, RBS estimates. The cost of living in the U.S. rose 0.2 percent in September, slowing from 0.4 percent in August, indicating the recovery from recession isn’t stoking inflation. The government report showed the cost of living is down 1.3 percent over the past 12 months. To contact the reporter on this story: Theresa Barraclough in Tokyo at tbarraclough@bloomberg.net.

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