Bloomberg News

Treasuries Fall Before Auction as Fed Leaves Stimulus Door Open

July 13, 2011

July 13 (Bloomberg) -- Treasuries fell, snapping a three- day advance, as Federal Reserve Chairman Ben S. Bernanke left open the possibility of more debt purchases to spur the economy and the U.S. prepared to sell $21 billion of 10-year notes.

Ten-year yields climbed after falling to 2.81 percent yesterday, the lowest level this year, as Treasuries rallied amid concern Europe’s sovereign-debt crisis was spreading. Yields rose earlier after higher-than-forecast economic growth in China reduced demand for government debt as a refuge.

“Treasuries are weaker as the market has to accommodate long-end supply and as investors are taking more risk,” said Michael Pond, co-head of interest-rate strategy in New York at Barclays Plc, one of 20 primary dealers that trade with the Fed. “Bernanke has been adamant that he believes in the recovery, but is leaving the door open to more stimulus, which is good for risk assets.”

Yields on the 10-year note increased seven basis points, or 0.07 percentage point, to 2.94 percent at 11:19 a.m. in New York, according to Bloomberg Bond Trader prices. The yield’s low yesterday was the least since Dec. 1. The 3.125 percent note maturing in May 2021 dropped 18/32 today, or $5.63 per $1,000 face amount, to 101 17/32.

Two-year note yields advanced one basis point to 0.36 percent after falling to 0.33 percent yesterday, the lowest level since June 27.

Yield Gap

The extra yield investors demand to own U.S. 10-year debt instead of two-year securities widened, ending a six-day slide that was the longest streak of decreases since May. The yield gap between 10- and two-year notes increased to 2.58 percentage points, from as low as 2.48 percentage points yesterday.

Stocks rose, with the Standard & Poor’s 500 Index advancing 1.3 percent, as Bernanke said the central bank is ready to move to spur the economy if necessary.

“The possibility remains that the recent economic weakness may prove more persistent than expected and that deflationary risks might reemerge, implying a need for additional policy support,” Bernanke said in testimony to the House Financial Services Committee today. “The Federal Reserve remains prepared to respond should economic developments indicate that an adjustment of monetary policy would be appropriate.”

One option, the Fed chief said, would be a third round of government bond purchases. Another would be to pledge to hold rates at record lows and the Fed’s balance sheet at a record high of almost $3 trillion for a longer period of time.

Second Round

The comments were Bernanke’s first since a report on July 8 showed the economy added 18,000 jobs in June, fewer than the most pessimistic forecast in a Bloomberg News survey. The Fed’s second round of quantitative easing, $600 billion of Treasury purchases, ended on schedule June 30.

The 10-year notes scheduled for sale today yielded 2.935 percent in pre-auction trading, compared with 2.967 percent the last time the notes were sold on June 8. Investors bid for 3.23 times the amount of debt offered last month, up from 3 times at the May sale and an average of 3.11 for the past 10 auctions.

The 10-year note auction “will also serve as a litmus test for post-QE2 investor demand,” wrote George Goncalves, head of interest rate strategy at Nomura Holdings Inc. in New York, which as a primary dealer is obliged to bid at U.S. debt sales.

The U.S. sold $32 billion of three-year debt yesterday in the first note auction since the Federal Reserve’s $600 billion of Treasury purchases ended on June 30. The bid-to-cover ratio, which gauges demand by comparing bids with the amount offered, was 3.22, versus an average of 3.14 for the prior 10 sales.

30-Year Auction

The government plans to conclude this week’s sales with a $13 billion auction of 30-year bonds tomorrow.

Bill Gross, who runs the world’s biggest debt fund at Pacific Investment Management Co., increased holdings of Treasuries and bonds outside the U.S. last month, while cutting money-market securities.

Gross boosted his $243 billion Total Return Fund’s investment in U.S. government debt to 8 percent of assets in June from 5 percent in May, according to Newport Beach, California-based Pimco’s website. Bonds from non-U.S. developed markets rose to 13 percent of Pimco’s holdings from 10 percent. Cash and equivalents dropped to 29 percent from 35 percent.

U.S. debt has returned 3.6 percent in 2011, according to the Bank of America Merrill Lynch Treasury Master index. The Standard & Poor’s 500 Index gained 6.1 percent.

European Crisis

Treasuries rallied yesterday as Moody’s Investors Service cut Ireland’s credit rating to junk. Greece is struggling to avert a default, and investors concerned at borrowing levels in Italy and Spain sent yields on 10-year securities in those nations to the highest in more than a decade.

Bonds reversed course today as data showed China’s gross domestic product rose 9.5 percent in the second quarter, beating estimates and fueling optimism the world’s second-largest economy is maintaining momentum.

Ten-year yields will advance to 3.53 percent in the U.S. by Dec. 31 as the Fed keeps its benchmark interest rate unchanged, according to Bloomberg surveys of banks and securities companies with the most recent forecasts given the heaviest weightings.

--With assistance from Lucy Meakin in London and Shigeru Sato and Takako Taniguchi in Tokyo. Editors: Greg Storey, Paul Cox

To contact the reporters on this story: Cordell Eddings in New York at ceddings@bloomberg.net; Susanne Walker in New York at swalker33@bloomberg.net

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


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