Treasury Two-Year Yield Drops to Record Low on Economic Slowdown Concern

Treasuries rose, pushing two-year note yields to a record low, after Federal Reserve reports showing that manufacturing cooled in the Philadelphia and New York regions raised concern the economic recovery is faltering.

Yields on two-year notes, the most sensitive to changes in central bank policy, touched 0.5767 percent, the lowest since regular sales of the securities began in 1975. Bank of America Merrill Lynch Index data show Treasuries gained 1.3 percent in the past month, versus a 2.5 percent drop in the Standard & Poor’s 500 Index, as investors sought the relative safety of U.S. government debt.

“We’ve had weak manufacturing data and a drop in equities that are weighing on the Treasury market,” said Michael Cloherty, head of interest-rate strategy in New York at Royal Bank of Canada, one of the 18 primary dealers that trade directly with the Fed. “The fundamental low-growth economic picture hasn’t changed. Still, yields this low require constant bad news to hold.”

The yield on the 10-year Treasury note dropped 7 basis points, or 0.07 percentage point, to 2.97 percent at 3:23 p.m. in New York, according to BGCantor Market Data. It touched 2.96 percent, the lowest level since July 7. The 3.5 percent security maturing in May 2020 rose 5/8, or $6.25 per $1,000 face amount, to 104 15/32.

Thirty-year yields fell 7 basis points to a one-week low of 3.96 percent. The two-year yield’s previous record low, 0.5856 percent, was reached on June 30.

Yield Curve

The extra yield that investors demand to hold Treasury 10- year notes over 2-year securities, known as the yield curve, narrowed 6 basis points, the most in more than two weeks, to 238 basis points. It touched 294 basis points on Feb. 18, the steepest ever.

“The perception is that there is an economic slowdown,” said Andy Richman, who oversees $10 billion as a strategist in Palm Beach, Florida for SunTrust Bank’s private wealth management division. “The Fed is in no hurry to raise rates.”

Traders reduced bets policy makers will raise the benchmark interest rate by their January meeting, futures on the CME Group Inc. exchange showed. The probability fell to 23 percent, from 43 percent a month ago. The rate has been at a record low range of zero to 0.25 percent since December 2008.

A gauge of trader expectations for prices, the gap between yields on U.S. 10-year notes and Treasury Inflation Protected Securities, narrowed to 1.81 percentage points today from this year’s high of 2.49 percentage points in January.

Consumer Price Report

A Labor Department report tomorrow will show the consumer price index fell 0.1 percent in June, a third monthly decline, according to the median forecast in a Bloomberg survey.

The S&P 500 Index fell as much as 1.3 percent before paring losses to 0.8 percent

Minutes released yesterday of the Federal Open Market Committee’s June meeting showed officials noted that risks to the recovery increased. The Fed trimmed its outlook for inflation this year to a range of 1 percent to 1.1 percent, down from 1.2 percent to 1.5 percent in April.

U.S. securities extended gains after data showed manufacturing in the Philadelphia region cooled in July as orders fell for the first time in a year. The Fed Bank of Philadelphia’s general economic index fell to 5.1, the lowest level since August 2009, from 8 in June. Readings above zero signal growth.

‘Poor Data’

“There has been a continuing string of poor data, which is at odds with the positive earnings season,” said George Goncalves, head of interest-rate strategy at primary dealer Nomura Holdings Inc. “The data is telling you things are slowing down.”

The New York Fed’s general economic gauge, known as the Empire State Index, dropped to 5.1, lower than the median forecast of 18 in a Bloomberg News survey of economists, data showed today.

U.S. manufacturing output moved down 0.4 percent in June after three months of gains at or near 1 percent, a Fed report on industrial production showed.

The Fed lowered its central tendency forecast for 2010 growth to a range of 3 percent to 3.5 percent versus 3.2 percent to 3.7 percent in April, the bank’s June meeting minutes showed.

“The economic outlook had softened somewhat, and a number of members saw the risks to the outlook as having shifted to the downside,” the Fed’s. “A few participants cited some risk of deflation,” the minutes said.

Budget Deficit

The Fed and U.S. agencies have lent, spent or guaranteed about $8.2 trillion to lift the economy from the worst slump since the Great Depression, according to data compiled by Bloomberg. The White House budget office projects the federal deficit this year will exceed $1.5 trillion, or 10.6 percent of gross domestic product, and anticipates the deficit five years into the future will remain as high as $751 billion.

Former Fed Chairman Alan Greenspan said reducing the deficit is “going to be far more difficult than anybody imagines” after “a decade of major increases in federal spending and major tax cuts.”

“Unless we start to come to grips with this long-term outlook, we are going to have major problems,” said Greenspan, who led the U.S. central bank from 1987 to 2006.

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

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