Bloomberg News

Treasuries Drop as ECB Coordination With Fed Saps Refuge Demand

September 15, 2011

Sept. 15 (Bloomberg) -- Treasury 10-year note yields rose the most in more than three weeks as the European Central Bank said it will work with the Federal Reserve and other central banks to lend euro-area financial institutions dollars, damping demand for a refuge.

Thirty-year bonds erased gains posted yesterday after the Treasury sold $13 billion of the securities at the lowest yields on record as investors bet the Fed will announce plans to buy more longer-maturity debt next week. The ECB’s lending plan was announced a day after Germany and France signaled their commitment to keeping Greece in the euro region.

“Europe isn’t going to fall into the abyss,” said Anthony Cronin, a trader in New York at Societe Generale SA, one of the 20 primary dealers that trade with the Fed. “That helped to fuel the fire and a lot of selling. It takes away some of the flight to quality.”

Yields on 10-year notes climbed 10 basis points, or 0.10 percentage point, to 2.08 percent at 5:14 p.m. in New York, according to Bloomberg Bond Trader prices. The 2.125 percent securities due in August 2021 fell 7/8, or $8.75 per $1,000 face amount, to 100 3/8.

The Standard & Poor’s 500 Index gained 1.7 percent, and the Stoxx Europe 600 Index rallied 2 percent. The euro advanced 0.9 percent to $1.3877.

Ten-Year Yields

Ten-year note yields increased as much as 13 basis points, the most since Aug. 24, to 2.12 percent. They decreased to a record low 1.8770 percent three days ago.

A drop of more than one point in the 30-year bond today pushed the yields up nine basis points to 3.36 percent. Yields on two-year notes were little changed at 0.19 percent.

U.S. debt securities have rallied in 2011 as speculation Europe’s sovereign-debt crisis will cripple the region’s financial institutions and evidence of a stalled U.S. economic recovery spurred demand for the safest assets.

The government auctioned $32 billion of three-year notes, $21 billion of 10-year debt and yesterday’s 30-year bonds at record low yields this week.

Treasuries have returned 8 percent in 2011 in what would be their best year since the depths of the financial crisis in 2008, according to Bank of America Merrill Lynch indexes. U.S. 30-year bonds have returned 24 percent.

Central Banks

The ECB said that in coordination with the Fed, the Bank of England, the Bank of Japan and the Swiss National Bank it will conduct three U.S. dollar liquidity-providing operations with a maturity of about three months.

The loans are in addition to the bank’s regular seven-day dollar offerings and will be conducted as fixed-rate tenders with full allotment, the ECB said in a statement.

European governments still need to act to contain sovereign-debt turmoil, according to Michael Cloherty, head of U.S. rates strategy for fixed income and currencies in New York at Royal Bank of Canada, a primary dealer.

“This buys some time, but there’s still underlying issues that have to be addressed,” Cloherty said. “This is a very different situation than in 2008 after the Reserve fund broke the buck, which caused a massive liquidity problem everywhere. This is more a capital than a liquidity problem. We will still need to see significant government intervention to address the underlying issues.”

Reserve Primary Fund

Reserve Primary Fund in 2008 became the first money-market fund in 14 years to fall below $1 a share, exposing investors to losses as the bankruptcy of Lehman Brothers Holdings Inc. deepened a crisis of confidence in lending markets.

French President Nicolas Sarkozy and German Chancellor Angela Merkel said yesterday in a statement that they’re “convinced” Greece will stay in the euro region as they faced international calls to step up efforts in stemming the region’s debt crisis.

“We’ve had two days in a row of renewed effort on the part of European Union leadership to coordinate messages and now possibly actions to stop the quick ratcheting down in asset values,” said Jim Vogel, interest-rate strategist at FTN Financial in Memphis, Tennessee. “The contagion was moving beyond banks.”

The difference in yield between 10-year Treasuries and inflation-protected debt, a measure of the outlook for consumer prices known as the break-even rate, increased to 1.97 percentage points after touching 1.90 percentage points, the lowest since October 2010.

Consumer Prices

Consumer prices advanced 0.4 percent in August after a gain of 0.5 percent in the previous month, the Labor Department reported. The median forecast of 84 economists in a Bloomberg News survey was for an increase of 0.2 percent.

The Philadelphia Fed’s general economic index increased to minus 17.5 this month from minus 30.7 in August. The median forecast was minus 15. Readings less than zero signal a contraction of manufacturing in eastern Pennsylvania, southern New Jersey and Delaware. Manufacturing in the New York region unexpectedly shrank in September at a faster pace, a report from the New York Fed showed.

Five-year note yields increased six basis points to 0.94 percent even as the Fed bought $3.299 billion of securities maturing from October 2015 to February 2017. The purchase is part of the policy of reinvesting the proceeds of maturing assets on its balance sheet to keep borrowing costs low.

The Federal Open Market Committee may decide to replace holdings of shorter-term Treasuries with longer maturities at its two-day policy meeting starting Sept. 20.

Swaps Markets

The premium European banks pay to borrow in dollars through the swaps markets decreased after the ECB said it will lend euro-area banks dollars to ensure they have enough of the U.S. currency through year-end.

The cost of converting euro-based payments into dollars, as measured by the three-month cross-currency basis swap, fell 5.28 basis points to 93.13 basis points below the euro interbank offered rate, or Euribor, indicating a lower premium to buy the greenback, according to data compiled by Bloomberg.

The one-year basis swap dropped 3.8 basis points to 66.75 basis points. Basis swaps allow banks to borrow in one currency, while simultaneously lending in another.

--With assistance from Elizabeth Stanton in New York. Editors: Dennis Fitzgerald, Greg Storey

To contact the reporter on this story: 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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