Treasuries Decline After China's Stronger Yuan Fixing Saps Safety Demand

Treasuries fell for a third day after China’s central bank strengthened its daily reference rate for the yuan by the most in five years.

Longer-maturity bonds led the decline as the decision by People’s Bank of China spurred confidence the global economic recovery is gaining momentum. The difference in yield between two-year interest-rate swaps and similar-dated Treasuries narrowed for a third day yesterday, signaling investors are gaining confidence in the worldwide recovery.

“If the yuan news leads to more confidence in risky assets there will be less demand for Treasuries,” said Kei Katayama, who helps oversee $37.3 billion as leader of the foreign fixed- income group in Tokyo at Daiwa SB Investments Ltd. in Tokyo. “There will be a normalization in the financial situation and investors will shift to riskier assets by year-end.”

The yield on the 10-year note climbed two basis points to 3.26 percent as of 6:41 a.m. in London, according to BGCantor Market Data. The 3.5 percent security due May 2020 fell 1/8, or $1.25 per $1,000 face amount, to 102 1/32.

The PBOC set the reference rate for yuan trading 0.43 percent stronger today, reflecting its appreciation yesterday. China announced on June 19 it was scrapping the yuan’s 6.83 peg to the dollar adopted to protect exporters during the financial crisis.

The yuan weakened 0.3 percent today to 6.82 per dollar, according to the China Foreign Exchange Trade system.

Auction Demand

Investor demand for bonds sold last week by European nations such as Spain renewed confidence in the countries’ ability to fund budget deficits. This week the Netherlands, Portugal and Italy plan to raise funds through debt sales.

The European Central Bank started buying bonds of debt- ridden nations last month to support a near $1 trillion rescue plan forged by the European Union. ECB Executive Board member Juergen Stark said yesterday the central bank’s government bond- purchase program is of a “temporary nature” to help restore investor confidence in the region.

“Risk appetite is gaining momentum,” said Hideo Shimomura, who helps oversee the equivalent of $55.5 billion as chief investor in Tokyo at Mitsubishi UFJ Asset Management Co., a unit of Japan’s biggest bank. “The swap spread will move towards 30 basis points. People may start unwinding positions against the euro.”

Two-year interest-rate swap spreads shrank to 31.52 basis points yesterday, the narrowest since May 14, according to data compiled by Bloomberg. The gap was little changed at 31.98 basis points today. Swap spreads reflect the difference between the rate to exchange floating for fixed interest payments and Treasury yields for two years.

Two-Year Notes

Treasury two-year yields were near the lowest since May on speculation the Federal Reserve will this week reiterate its pledge to keep interest rates near zero to spur a recovery. The Federal Open Market Committee starts a two-day meeting today.

“The FOMC is not going to move and the language is not going to change because it’s too early for the Fed to even contemplate moving rates,” said Kumar Palghat, who helps manage the equivalent of $1.6 billion at Kapstream Capital in Sydney. “Given the problems we’ve had, you’d expect the Fed to be at least on hold for three years since the last rate cut -- so we’re half way into it.”

The two-year yield was little changed at 0.73 percent. The yield fell to 0.69 percent on June 17, the lowest since May 25.

Policy makers have kept the Fed funds rate in a range of zero to 0.25 percent since December 2008 and the central bank’s pledge that interest rates will stay very low for an “extended period” has been in place since March 2009. The Fed will hold its benchmark at a record-low at this week’s meeting, according to all 96 economists surveyed by Bloomberg News.

‘Relatively Strong’

The U.S. will auction $40 billion in two-year debt today, $38 billion in five-year notes tomorrow and $30 billion in seven-year securities on June 24. The total is $5 billion less than last month’s sales.

“The two-year auction won’t be a home run, but demand in the front end is still relatively strong,” said Jason Rogan, director of U.S. government trading in New York at Guggenheim Partners LLC, a brokerage for institutional investors.

Indirect bidders, an investor class that includes foreign central banks, bought 36 percent of the two-year notes at the prior auction on May 25, compared with an average of 42 percent over the past 10 sales.

The two-year notes to be auctioned today yielded 0.75 percent in pre-auction trading, compared with 0.769 percent at the previous sale, the lowest on record.

To contact the reporter on this story: Candice Zachariahs in Sydney at czachariahs2@bloomberg.net.

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