Bloomberg News

Treasury Yields Climb Most in 3 Months on Europe Outlook

June 09, 2012

Treasury yields had the biggest weekly increase in almost three months as bets European leaders may make progress stemming their debt crisis damped haven demand and the U.S. prepared to sell $66 billion of notes and bonds.

U.S. bond yields climbed amid reduced volume after tumbling to record lows on June 1. European officials were awaiting a request for aid to shore up Spanish banks, European Central Bank Vice President Vitor Constancio said yesterday. Federal Reserve Chairman Ben S. Bernanke said on June 7 the U.S. has options for further monetary easing.

“There has been cautious optimism that Europe is ready to get their act together,” said Larry Milstein, managing director in New York of government and agency debt trading at R.W. Pressprich & Co., a fixed-income broker and dealer for institutional investors. “And the market still has supply to deal with. Still, policy makers seem to only act when they are at the edge of a cliff.”

The 30-year bond yield increased 23 basis points, or 0.23 percentage point, to 2.75 percent yesterday in New York, according to Bloomberg Bond Trader prices, from 2.52 percent on June 1. It was the biggest jump since the five days ended March 16. The 3 percent security due in May 2042 slid 4 7/8, or $48.75 per $1,000 face amount, to 105 5/32.

Ten-year note yields increased 18 basis points, also the most since March 16, to 1.64 percent.

Volume Drops

Trading volume shrank. About $227 billion of Treasuries changed hands this week through ICAP Plc, the world’s largest interdealer broker. It was a 36 percent drop, the most since the five days ended May 25. Volume surged 148 percent last week to $351 billion.

Ten- and 30-year yields reached the lowest ever, 1.4387 percent and 2.5089 percent, on June 1 as government data showed U.S. job growth trailed estimates and concern festered Europe’s debt crisis would worsen. They touched 2012 highs in March, 3.49 percent for the long bond and 2.4 percent for the 10-year note.

Treasuries have returned 2.99 percent this quarter, compared with a 2 percent gain by sovereign debt of all Group of Seven nations, Bank of America Merrill Lynch indexes showed.

A valuation measure showed U.S. government bonds were at almost the most expensive level ever. The term premium, a model created by economists at the Fed, was at negative 0.83 percent yesterday after reaching negative 0.94 percent, the record, a week earlier. The average over the past year is negative 0.44. A negative reading indicates investors are willing to accept yields below what’s considered fair value.

Aid Package

European finance ministers will discuss this weekend a possible aid package for Spain, according to an official who declined to be identified because the matter is confidential. Greece, Ireland and Portugal have received international bailouts.

Fitch Ratings downgraded Spain by three levels to BBB on June 7, taking the rating to two steps off non-investment grade. The cost to the state of shoring up banks may amount to as much as 100 billion euros ($125 billion), compared with its previous estimate of 30 billion euros, Fitch said.

Spain’s 10-year bond yield climbed as much as 18 basis points yesterday to 6.27 percent. Prime Minister Mariano Rajoy said for the first time he’s discussing with European leaders how to help Spanish banks.

“There remains a fair amount of uncertainty in the air, and asset markets have been fairly disappointed about the lack of commitment from Bernanke with respect to additional imminent easing,” Christopher Sullivan, who oversees $1.9 billion as chief investment officer at United Nations Federal Credit Union in New York, said yesterday. “Any backup in yield will be met with buying until something changes with regards to the global growth picture and Europe.”

ECB Ready

ECB President Mario Draghi said on June 6 policy makers were “ready to act,” after leaving their benchmark interest rate at a record low 1 percent.

While the 10-year note has climbed amid the European debt crisis and concern U.S. economic growth is faltering, its yield is only about 10 basis points rich to fair value given the negative performance of other markets, including equities and commodities, according to Credit Suisse Group AG, one of the 21 primary dealers that trade with the Fed.

“The outlook and corresponding behavior within other markets has been so dramatic that even while rates have rallied, they have in some senses moved from rich to closer to the fair- value yield,” analysts at the firm, including Eric Van Nostrand in New York, wrote in a report June 7. “Looking at prior richening trends, there appears to still be scope for Treasury yields to make a move lower should the Fed decide to ease further.”

Further Drop

U.S. 10-year note yields will drop to match those on Japanese government bonds, about 0.8 percent, according to the investor at Mizuho Asset Management Co. who predicted the rally in Treasuries that began in 2010.

Prospects for deflation and additional monetary easing by central banks will push the U.S. yield to its Japanese peer’s level at year-end, said Akira Takei, head of the international fixed-income department for Mizuho Asset, a unit of Japan’s third-biggest listed bank. He spoke in an interview.

Hedge-fund managers and other large speculators decreased their net-short position in 10-year note futures in the week ending June 5, according to U.S. Commodity Futures Trading Commission data.

Speculative short positions, or bets prices will fall, outnumbered long positions by 37,892 contracts on the Chicago Board of Trade. Net-short positions fell by 43,186 contracts, or 53 percent, from a week earlier, the Washington-based commission said in its Commitments of Traders report.

Treasury Auction

The U.S. will auction next week $32 billion of three-year notes, $21 billion of 10-year securities and $13 billion of 30- year bonds. The three sales start June 12.

Bernanke said June 7 the European debt crisis “poses significant risks to the U.S. financial system and economy and must be monitored closely.” Speaking to Congress’s Joint Economic Committee in Washington, he refrained from discussing steps the Fed might take to protect U.S. growth.

The Federal Open Market Committee opens a two-day policy meeting on June 19. It has kept its key interest rate at zero to 0.25 percent since December 2008 and bought $23.3 trillion of debt in two rounds of quantitative easing from 2008 to 2011.

Yields indicate investors expect inflation to hold in check in the U.S., providing Bernanke the room for further stimulus.

Inflation Bets

The difference in yields between 10-year notes and Treasury Inflation Protected Securities, which represents traders’ expectations for inflation over the life of the debt, was 2.14 percentage points, down from this year’s high of 2.45 percentage points in March. The average over the past decade is 2.15 percentage points.

Growth in the U.S. consumer price index slowed to 1.8 percent last month from a year earlier after rising 2.3 percent in April, economists in a Bloomberg News survey forecast before the Labor Department reports the data on June 14.

Political and fiscal risks may lead to another downgrade of the U.S.’s credit rating by 2014 by Standard & Poor’s, which affirmed yesterday its negative outlook on the nation’s debt.

S&P stripped the U.S. of its top AAA ranking on Aug. 5, cutting it to AA+ while criticizing the nation’s political process and saying spending cuts agreed on by lawmakers wouldn’t be enough to reduce record deficits. Treasuries surged after the move, and while Moody’s Investors Service and Fitch Ratings have kept their top grades on the U.S., both have a negative outlook.

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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