Bloomberg News

Treasuries Post Biggest Weekly Decline in Eight Months on Growth

March 17, 2012

Treasury (YCGT0025) 10-year notes declined the most in eight months after the Federal Reserve drove investors into riskier assets and reduced speculation of further debt purchases by increasing its assessment of the U.S. economy.

Yields on the benchmark note rose to the highest level in more than four months yesterday as a report showing the cost of living rose in February added to concern inflation may accelerate as the recovery strengthens. The difference in yields between 10-year notes and Treasury Inflation Protected Securities climbed to 2.41 percentage points, the most since August, as the U.S. prepared to sell $13 billion of the securities on March 22.

“The bear market has begun,” said James Combias, the New York-based head of Treasury trading at Mizuho Securities USA Inc., one of 21 primary dealers that trade with the central bank. “The world has been parked out in the bond market.”

The 10-year yield rose 27 basis points, or 0.27 percentage point on the week, to 2.30 percent in New York, according to Bloomberg Bond Trader prices. The increase was the most since yields rose 32 basis points in the five days ended July 1. The 2 percent note due February 2022 dropped 2 11/32, or $23.44 per $1,000 face amount, to 97 12/32.

Thirty-year bond yields closed up 23 basis points at 3.41 percent, after climbing as high as 3.48 percent on March 15, the highest since October.

Fed Speculation

Volatility jumped this week from the lowest level in more than four years. Bank of America Merrill Lynch’s MOVE index, which measures price swings based on options, increased on March 14 to 89.7 basis points, the highest since Jan. 3. It reached 69.9 basis points on March 12, the least since July 2007 and closed yesterday at 84.9.

“The economy is getting better so we are going to higher ranges,” said Michael Franzese, managing director and head of Treasury trading at Wunderlich Securities Inc. in New York. “Some people took profits off the table.”’

While Fed policy makers refrained at their March 13 meeting from new actions to lower borrowing costs and said the U.S. labor market is gathering strength, they also reiterated a pledge to keep the benchmark interest rate at almost zero through at least late 2014.

The central bank bought $2.3 trillion of securities in two rounds of so-called quantitative easing from December 2008 to June 2011 in a bid to boost the economy.

Forward-Rate Structure

Forward markets for overnight index swaps, whose rate shows what traders expect the federal funds effective rate to average over the life of the contract, signal a quarter-percentage advance in approximately the September and October 2013 period, according to data compiled by Bloomberg as of March 15. Last month, such an increase in the effective rate wasn’t predicted until early 2014. This year the effective rate has averaged 0.15 percentage point below the top end of the target range that the Fed reiterated three days ago.

“In the past few weeks, the market had been thinking the forward-rate structure it had priced in was too flat and had rates generally too low,” said Jim Lee, head of short-term markets and futures and options strategy in Stamford, Connecticut, at Royal Bank of Scotland Group Plc’s RBS Securities Inc. “There are still people thinking that this move is just beginning.”

After the Fed’s March 13 statement, a measure of traders’ inflation expectations that the central bank uses to help determine monetary policy climbed to 2.56 percent on March 13 from its 2012-low of 2.37 percent March 5. The five-year, five- year forward break-even rate, which projects what the pace of price increases may be starting in 2017, hasn’t risen above 2.62 percent this year and is below the 2.76 percent average since 2002.

Inflation Expectations

The consumer-price index climbed 0.4 percent in February, matching the median forecast of economists surveyed by Bloomberg News, after increasing 0.2 percent the prior month, the Labor Department reported yesterday. The so-called core measure, which excludes more volatile food and energy costs, climbed 0.1 percent, less than the 0.2 percent projected.

Inflation “has been subdued in recent months although prices of crude oil and gasoline have increased lately,” the Fed said in its March 13 statement. The increase in oil will “push up inflation temporarily, but the committee anticipates that subsequently inflation will run at or below the rate that it judges most consistent with its dual mandate.”

Term Premium

At the same time, valuation measures show government debt is becoming less expensive. The term premium, a model created by economists at the Fed, rose to negative 0.34 percent yesterday, the least since October. The figure touched negative 0.79 percent on Feb. 2, the most expensive ever, and compares with the average of positive 0.56 percent over the past decade. A negative reading indicates investors are willing to accept yields below what’s considered fair value.

FTN Financial Chief Economist Christopher Low, the most accurate forecaster of Treasury note yields last year, said slowing U.S. economic growth will push 10-year yields down to 2.1 percent by year end.

“We expect interest rates to fall in the second half of this year,” Low said. While yields may climb to 2.5 percent over the next few months, they will trade primarily within a range of 1.8 percent to 2.3 percent, he said.

To contact the reporters on this story: Susanne Walker in New York at swalker33@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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