Bloomberg News

Treasuries Drop on Rating Concern; 10-Year Yield Back Above 3%

June 02, 2011

June 2 (Bloomberg) -- Treasuries fell as Moody’s Investors Service said it expects to place the U.S. government’s Aaa rating under review for possible downgrade if there is no progress on increasing the statutory debt limit in coming weeks.

Most of the losses occurred earlier as 10-year note yields at almost the lowest level in 2011 discouraged demand before the Labor Department’s payrolls report tomorrow. Yields rose back above 3 percent after tumbling yesterday the most in more than two months as hiring and manufacturing growth slowed.

“The debt limit has to be raised or it’s going to bring a severe blow to the U.S. economy,” Jason Rogan, director of U.S. government trading in New York at Guggenheim Partners LLC, a brokerage for institutional investors. “I don’t think it’s anything too shocking to the market.”

Yields on 10-year notes increased nine basis points, or 0.09 percentage point, to 3.03 percent at 5:19 p.m. in New York, according to Bloomberg Bond Trader prices. The 3.125 percent security due in May 2021 fell 26/32, or $8.13 per $1,000 face amount, to 100 3/4.

Two-year note yields advanced three basis points to 0.46 percent after touching 0.43 percent yesterday, the lowest level since Dec. 7. A drop of almost two points in the 30-year bond pushed yields to 4.25 percent today.

The Treasury Department reiterated yesterday that U.S. authority to borrow under the $14.29 trillion debt limit will expire Aug. 2.

Congressional Wrangling

A bill that would raise the debt limit by $2.4 trillion failed to win House passage May 31 in a vote that Democrats said was rigged to ensure its defeat.

“If the negotiating stances of the two parties continue to be where they are now, in other words very far apart, and an agreement on the raising of the debt limit continues to look remote, probably by mid-July we would consider putting the rating on review for downgrade,” said Steven Hess, senior credit officer at Moody’s in New York.

In April, Standard & Poor’s put the U.S. government on notice that it risks losing its AAA credit rating unless policy makers agree on a plan by 2013 to reduce budget deficits and the national debt.

“The Treasury market has been under pressure in the wake of the Moody’s warning that the U.S. needs to make progress on the debt ceiling issue in order to avoid a possible downgrade,” said Ian Lyngen, a government bond strategist at CRT Capital Group LLC in Stamford, Connecticut. “While it is unlikely that the U.S. will be downgraded, it is having an impact on the market in the absence of any other major events ahead of tomorrow’s payroll report.”

Gain in Swaps

Credit-default swaps that protect against default for one year have risen to 46.5 basis points from 24 basis points on May 16, when the U.S. reached its borrowing limit, according to data provided by CMA, which is owned by CME Group Inc. and compiles prices quoted by dealers in the privately negotiated market. The contracts pay the buyer face value if a borrower fails to meet its obligations, less the value of the defaulted debt.

The U.S. will auction $32 billion of three-year notes, $21 billion of 10-year debt and $13 billion of 30-year bonds next week, the Treasury Department said today, matching forecasts of 10 primary dealers in a Bloomberg News survey.

The $66 billion in securities to be sold in three daily auctions beginning June 7 matches the total in five of the past eight months. The government sold $72 billion of this combination of securities in May.

Treasury Returns

U.S. government debt returned 1.6 percent last month, the most since August, according to Bank of America Merrill Lynch indexes, with the sovereign-debt crisis in Europe and signs of a slowdown in America’s economy spurring refuge demand.

Treasuries rallied yesterday as reports showed companies added fewer jobs in May than economists forecast and manufacturing expanded at the slowest pace in more than a year, adding to evidence the central bank will keep its target rate for overnight lending between banks at virtually zero.

The 10-year note yields dropped 12 basis points to 2.94 percent yesterday, falling below 3 percent for the first time since Dec. 7 in the biggest decrease since March 16. The 14-day relative strength index of the yield slid below 30, indicating a reversal of direction may be imminent.

Employers added 170,000 positions in May after an increase of 244,000 in the prior month, the Labor Department is forecast by economists to report tomorrow. The unemployment rate may have fallen to 8.9 percent from 9 percent.

‘Headed Lower’

“If the economic data continues to weaken at the same pace that we have seen recently, there is no doubt in my mind that Treasury yields are still headed lower,” William O’Donnell, head U.S. government bond strategist in Stamford at RBS Securities Inc., said in a Bloomberg Television interview on “InsideTrack” with Erik Schatzker. As one of the 20 primary dealers, the unit of Royal Bank of Scotland Plc is obligated to participate in U.S. debt offerings.

U.S. companies added 38,000 workers in May, compared with 177,000 in the previous month, ADP Employer Services reported yesterday. The Institute for Supply Management’s factory index dropped to 53.5 last month from 60.4 in April, with readings above 50 indicating growth.

The Fed’s policy of quantitative easing failed to meet the “ultimate objective” of boosting employment and economic growth, according to Mohamed El-Erian, chief executive officer at Pacific Investment Management Co.

While the bond-purchase program pushed investors into higher-yielding assets such as stocks, the “transmission mechanism” to lower unemployment by driving more money into the economy didn’t work, El-Erian of Pimco, the world’s biggest manager of bond funds, said in a radio interview from Newport Beach, California, on “Bloomberg Surveillance” with Tom Keene.

The Fed began the second round of asset purchases, known as QE2, in November after buying $1.7 trillion in securities through last year, increasing the amount of money in circulation to prevent deflation. The purchase of $600 billion in Treasuries is due to end this month.

--With assistance from John Detrixhe and Susanne Walker in New York. Editors: Dennis Fitzgerald, Dave Liedtka

To contact the reporters on this story: Cordell Eddings in New York at ceddings@bloomberg.net; Daniel Kruger in New York at dkruger1@bloomberg.net

To contact the editor responsible for this story: Dave Liedtka at dliedtka@bloomberg.net


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