Treasury Yield Curve Flattest Since October on U.S. Jobs, Factory Reports

The extra yield investors demand to hold Treasury 10-year notes over 2-year debt fell to the lowest level since October as employment, manufacturing and housing reports heightened the risk of deflation.

The 10-year note yield stayed below 3 percent for a third day after breaching that level this week for the first time in more than a year. China’s manufacturing growth slowed in June, while the Labor Department’s payrolls report tomorrow is forecast by economists to show the U.S. lost jobs.

“Investors are moving out the curve in search of yield with front-end rates so low,” said Suvrat Prakash, an interest- rate strategist in New York at BNP Paribas SA, one of the 18 primary dealers that trade with the Federal Reserve. “Sentiment is turning against the growth story. The market is awaiting tomorrow’s number to see where to go from here.”

The difference between 10- and 2-year note debt, known as the yield curve, dropped for a fourth day to 2.32 percentage points at 4:02 p.m. in New York, after earlier touching 2.28 percentage points, the lowest level since Oct. 2.

The narrowing spread indicates investor preference for longer-term bonds, which tend to rise on slowing inflation. Two- year yields tend to track the outlook for the Fed’s target rate for overnight lending.

Yields on benchmark 10-year notes increased one basis point, or 0.01 percentage point, to 2.95 percent, according to BGCantor Market Data. The price of the 3.5 percent security maturing in May 2020 dropped 1/8, or $1.25 per $1,000 face amount, to 104 22/32.

Two-Year Yield

The two-year yield advanced three basis points to 0.63 percent after touching a record low 0.5856 percent yesterday. The 30-year yield was little changed at 3.89 percent.

U.S. employers cut 130,000 jobs last month, according to the median forecast of 82 economists in a Bloomberg News survey. A lower-than-expected 431,000 new jobs in May included a 411,000 jump in government hiring of temporary workers for the 2010 census, the Labor Department said June 4. Tomorrow’s payrolls report is due at 8:30 a.m. New York time.

Initial jobless claims climbed to 472,000 in the week ended June 26 from a revised 459,000 in the previous week, the Labor Department reported today. The median forecast of 46 economists in a Bloomberg News survey was for a decrease to 455,000 from a previously reported 457,000.

“The weak jobless claims number is in line with what we have been seeing: worsening economic condition and a global slowing of the economy, which have been supportive of Treasuries,” said Larry Milstein, managing director of government and agency debt trading in New York at R.W. Pressprich & Co., a fixed-income broker and dealer for institutional investors.

China’s Manufacturing

The Chinese government’s Purchasing Managers’ Index declined for a second month in June, falling to 52.1 from 53.9 in the previous month. The median forecast in a Bloomberg News survey of 12 economists was 53.2.

Two-year notes fell today as some investors bet that yields may have dropped to levels not justified by the outlook for the world’s largest economy.

Treasury investors should buy when prices dip, said William O’Donnell, head U.S. government bond strategist in Stamford, Connecticut, at the primary dealer Royal Bank of Scotland Group Plc, in a research note.

“The market has a little of that ‘What the heck do we do here?’ feel to it,” he wrote. “Trader bullishness is historically excessive in bonds and a potentially significant headwind for further price gains.”

Investors should enter trades that will profit from a rise in Treasury yields because current levels are “well below” fair value, according to Citigroup Inc.

‘Double Dip’ View

“Concerns over a double dip are now overstated,” Brett Rose, a New York-based fixed-income strategist at Citigroup, wrote in a research report today.

The difference between yields on 10-year notes and Treasury Inflation Protected Securities, a gauge of the inflation outlook known as the break-even rate, has narrowed 0.18 percentage point this week to 1.77 percentage points. It was 2.49 percentage points on Jan. 11.

The U.S. Treasury will sell $12 billion in 10-year TIPS on July 8. Inflation-indexed securities are intended to provide investors with a hedge against inflation. The securities rise or fall in value with movements in the government’s consumer price index, with a three-month lag.

The CPI dropped 0.2 percent in May in the biggest decrease since December 2008, the Labor Department reported June 17.

The Institute for Supply Management’s gauge of manufacturing fell to 56.2 in June from 59.7 a month earlier, the Tempe, Arizona-based group said today. A reading greater than 50 indicates expansion.

Pending home resales decreased 30 percent in May from the prior month, figures from the National Association of Realtors showed. The drop was the biggest since at least 2001.

To contact the reporter on this story: Cordell Eddings in New York at ceddings@bloomberg.net

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