Bloomberg News

Treasuries Drop on Speculation Growth to Lift Yields

June 04, 2012

Treasuries fell for the first time in four days on speculation the U.S. economy won’t slow enough to justify keeping yields at the record lows set last week.

Government securities interrupted a rally driven by Europe’s fiscal crisis and U.S. employment data that fell short of economists’ forecasts. A technical indicator showed the gains are poised to end after the 10-year yield slid last week the most since August. Federal Reserve Chairman Ben S. Bernanke will testify this week about the outlook for the U.S. economy.

“Treasuries are overvalued if the prices are based on an economic slowdown,” said Michael Franzese, managing director and head of Treasury trading at Wunderlich Securities Inc. in New York. “If this is a fear trade, where you have a situation where the market is fearing a major catastrophe, then they are not overvalued.”

Benchmark 10-year yields climbed seven basis points, or 0.07 percentage point, to 1.52 percent at 5:14 p.m. New York time, according to Bloomberg Bond Trader data. The 1.75 percent note maturing in May 2022 dropped 21/32, or $6.56 per $1,000 face amount, to 102 2/32. The all-time low yield was 1.4387 percent on June 1. The yield dropped 29 basis points last week and 36 basis points last month.

Thirty-year bond yields rose five basis points to 2.57 percent after touching a record low 2.5089 on June 1.

The long-bond yield could approach 2 percent, according to David Rosenberg, Toronto-based chief economist and strategist at Gluskin Sheff & Associates Inc.

Volume Decreases

Trading volume dropped to the lowest level since May 29 through ICAP Plc, the world’s largest interdealer broker, closing just above $212 billion in New York. The figure rose as high as $395 billion on May 31, the most since reaching a 2012 high of $439 billion on March 14. Its low for the year was $114 billion on May 7.

Valuation measures show Treasuries are at almost the most expensive levels ever. The term premium, a model created by economists at the Fed, was at negative 0.87 percent after closing June 1 at negative 0.94 percent, a record. A negative reading indicates investors are willing to accept yields below what’s considered fair value.

The 14-day relative-strength index for U.S. 10-year yields was at 29.8. A reading of less than 30 suggests to some traders rates have fallen too quickly and are set to change direction.

Price momentum signals, or trend oscillators, also indicated Treasuries yields may rise after hourly, daily, weekly and monthly indicators showed the securities are “overbought,” according to Royal Bank of Scotland Group Plc, one of the 21 primary dealers that trade with the Fed.

‘Overextended Market’

“The warning signs are there that this is an overextended market,” William O’Donnell, co-head of strategy Americas and head Treasury strategist at RBS Securities., said in a telephone interview. “We’re in uncharted territory.”

Thirty-year bonds, among the securities most sensitive to inflation because of their longer maturity, are outperforming the rest of the market.

The extra yield investors demand to buy the long bonds instead of 10-year notes touched 1.04 percentage points, the narrowest since Jan. 17. It reached 1.22 percentage points on Feb. 3, the most in 2012. The average for the past year is 1.15 percentage points.

The gap in yields between 10-year notes and Treasury Inflation Protected Securities, which represents traders’ expectations for the rate of inflation during the life of the bonds, was at 2.08 percentage points. It touched a 2012 low of 1.9 percentage points on Jan. 3 and a high of 2.45 percentage points on March 20.

A measure of price-increase predictions used by the Fed to set policy, the five-year, five-year forward break-even rate, which gauges the average inflation rate between 2017 and 2022, was 2.47 percent on May 30, down from a 2012 high of 2.78 percent on March 19.

Mortgage Securities

Treasury yields tumbled last week after a report showed the nation added 69,000 jobs in May, versus 150,000 projected by a Bloomberg poll of economists, fueling speculation the Fed may take more action to spur economic growth, including debt purchases under quantitative easing.

The Fed is more likely to buy additional government-backed mortgage securities, according to primary dealers Morgan Stanley and JPMorgan Chase & Co.

Morgan Stanley mortgage-bond analysts including Vipul Jain and Janaki Rao wrote that a third round of quantitative easing may involve about $200 billion in additional purchases of home- loan debt over nine months. Morgan Stanley said in a note the Fed would probably purchase $475 billion over nine months, including Treasuries and TIPS. It estimates odds are 80 percent the central will begin a third round of quantitative easing.

Operation Twist

The Fed may choose to begin a new round of its Operation Twist involving acquisitions of mortgage securities, rather than Treasuries, instead of buying debt, JPMorgan mortgage-bond analysts led by Matt Jozoff wrote. The size may be as much $100 billion to $200 billion, said the analysts.

The Fed bought $4.75 billion of Treasuries today due from June 2018 to May 2019 under Operation Twist, in which it’s replacing $400 billion of shorter-term debt in its holdings with longer maturities through this month.

Credit Suisse Group AG sees 80 percent odds of additional stimulus, with an emphasis on an extension of Operation Twist and some mortgage buying, Ira Jersey, an interest-rate strategist in New York at the primary dealer, said today.

The central bank, which meets June 19-20, purchased $2.3 trillion of debt in two rounds of quantitative easing from December 2008 to June 2011 to boost the economy.

Bernanke will testify June 7 in Washington before the Joint Economic Committee on the U.S. economic outlook.

‘Very Creative’

“The key question is going to be how open is he to another round of quantitative easing, and if he is, what form?” Gluskin Sheff’s Rosenberg said on Bloomberg Television’s “InBusiness” in an interview with Scarlet Fu. “They could buy Treasuries; well, bond yields are already at record lows. They could buy mortgages. Mortgage rates are at record lows. We know that Bernanke is willing to be very creative, he’s willing to be very aggressive and he’s not willing to let politics get in the way.”

German Chancellor Angela Merkel hardened her opposition to joint debt-sharing in the euro area in a speech June 2, amid speculation Greece will abandon the common currency, worsening Europe’s debt crisis.

Merkel gave no ground to Prime Minister Mariano Rajoy’s pleas that Germany consider new ideas to resolve the debt crisis. Her spokesman said today Spain can seek a bailout if needed and accept the conditions that will come with it.

To contact the reporters 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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