America's Shale Oil Boom May Boost Demand For US Treasuries

Shale oil and gas prospecting in the US has provided accidental benefits to American treasuries.

The US, the world' leading oil consumer, has lowered its energy imports in the wake of a shale oil boom. The nation could surpass Russia and Saudi Arabia as the world's largest producer of oil, according to the International Energy Agency.

Lower energy expenses have cut into inflation at a time when the world's leading economy is inching closer towards energy independence.

Economists have said that consumer prices would rise less than 2% for a second consecutive year in 2014. The last time that inflation rose less than 2% for two straight years during an expansion was in 1964 and 1965, according to the US Labor Department.

Slowing inflation, which increases the purchasing power of fixed-rate payments, would lend support to treasuries, particularly after the US Federal Reserve's decision to reduce the pace of its bond buys triggered their first annual losses since 2009.

Treasuries are now off to their best start in five years. Yields on 10-year treasuries are expected to climb to 3.45% by the end of the year, according to a Bloomberg poll of 68 economists.

Yields on the 10-year note hovered at 2.84% as of 14:03 hours in Tokyo, following a three week decline to 2.82% in the period through 17 January, Bloomberg reported. The price of the 2.75% bond due in November 2023 was 99 1/4.

The $8.3tr of US government debt included in the Bank of America Merrill Lynch US Treasury Index has returned 0.8% in January after losing 3.4% in 2013.

Spending fewer dollars to import crude oil means the greenback would not weaken whenever the demand for crude rises, eventually helping preserve the value of treasuries for foreign creditors.

Smaller consumer-price gains are helping boost the appeal of treasuries as inflation-adjusted yields rise, said Jack McIntyre, a money manager at Brandywine Global Investment Management, which oversees assets worth $45bn.

Rising US oil production means "lower inflation than it would otherwise be, lower interest rates than would otherwise be," said David Kotok, the chairman and chief investment officer of Cumberland Advisors, which manages $2.2bn.

"We don't have to provide the incentives to recycle the dollar back from a foreign holder, be it friend or enemy" with higher bond yields, Kotok added.

America's foreign lenders held almost half of the nation's $11.8tr in marketable securities as of November 2013, with China and Japan together owning $2.5tr.

Learning From History

America began pursuing energy independence after the Arab oil embargo in 1973, when the US assisted Israel in the Yom Kippur War.

The embargo led to unending fuel shortages in the US and fuelled inflation, pushing the economy into recession.

America's borrowing costs soared as investors demanded more compensation to hold US government debt, and yields on 10-year treasuries surpassed 8% in 1974.

An inflation rate of 12.34% that year meant that the holders of Treasuries were left nursing a loss of about 5.3% in real terms, according to Barclays data.