Treasuries Decline as Stocks Advance on Increase in Investor Risk Appetite

Treasuries fell, pushing up two-year yields from a record low, as stocks rose after Genzyme Corp. received a takeover approach and the euro gained after 84 of 91 European banks passed stress tests, fueling risk appetite.

U.S. bonds earlier erased losses on speculation the stress tests may not prove that European lenders are strong enough to weather a government default. The U.S. prepared to sell $104 billion in bonds next week.

“We’ve been trading with stocks,” said Richard Bryant, senior vice president in fixed income at MF Global Inc. in New York, a broker of exchange-traded futures. “We’re through the stress tests, and now we have supply next week.”

The two-year note yield rose 2 basis points, or 0.02 percentage point, to 0.58 percent at 4:25 p.m. in New York, according to BGCantor Market Data. It earlier dropped to a record 0.5516 percent. The 0.625 percent security due in June 2012 fell 1/32, or 31 cents per $1,000 face amount, to 100 3/32.

The 10-year note yield rose 6 basis points to 2.99 percent. It touched 2.85 percent on July 21, the lowest since April 2009.

The Standard & Poor’s 500 Index rose 0.8 percent to 1,102.66 at 4 p.m. in New York, its first gain above 1,100 since June 22. The euro gained 0.2 percent to $1.2915.

Treasuries reversed earlier losses after a draft document showed Europe’s stress tests were set to ignore the majority of banks’ holdings of sovereign debt after regulators decided against testing securities held in their banking books. Banks were only examined on European sovereign-debt losses for the bonds they trade, it showed.

Trading Book Only

“The haircuts are applied to the trading book portfolios only, as no default assumption was considered,” the European Central Bank said in a confidential document July 22 titled “EU Stress Test Exercise: Key Messages on Methodological Issues.”

Lenders hold about 90 percent of their Greek government bonds in their banking book and 10 percent in their trading book, according to a survey by Morgan Stanley analysts led by Huw van Steenis.

“It should have been completely across the full book, given how intertwined the banking system in Europe is,” George Goncalves, New York-based head of interest-rate strategy at primary dealer Nomura Holdings Inc., said. The firm is one of 18 primary dealers that trade with the Federal Reserve. “The fact that the assumptions were different for the held-to-maturity portfolio along with low capital raise needs is why the U.S. bond market is being skeptical.”

The Committee of European Banking Supervisors said the seven banks that failed the tests had a combined capital shortfall of 3.5 billion euros ($4.5 billion). The seven were Germany’s Hypo Real Estate Holding AG, Agricultural Bank of Greece SA and five Spanish savings banks.

‘Hard to Determine’

“It’s hard to determine what exactly the stress tests mean and how good of a gauge they are in telling you the health of the European banking sector,” said MF Global’s Bryant.

Treasuries fell earlier today after U.K. GDP rose 1.1 percent in the three months through June following a 0.3 percent increase in the previous quarter, the Office for National Statistics said. Economists forecast a 0.6 percent gain, according to the median in a Bloomberg News survey.

The Ifo institute said its German business climate index jumped to 106.2, the highest since July 2007, from 101.8 in June, the biggest monthly increase since records for a reunified Germany began in 1990.

While U.S. economic reports over the past month were weaker than some analysts projected, 10-year notes were still poised for a weekly loss amid optimism corporate earnings and a law extending payments to the unemployed would maintain growth. Technical considerations also point to Treasury declines, according to primary dealer Royal Bank of Scotland Group Plc.

‘Coming to an End’

“There are growing signs in the technicals that the honeymoon in Treasuries is coming to an end for the near-term,” William O’Donnell, managing director at RBS Securities in Stamford, Connecticut, wrote in a note to clients. “I see signs of brewing bearish divergence in the charts of all benchmark Treasury securities -- save for the 30-year bond.”

The 10-year yield will climb to 3.30 percent by year-end, according to a Bloomberg survey of banks and securities companies with the most recent forecasts given the heaviest weightings.

Ten-year yields rose 6 basis points yesterday, the most in more than a week. Microsoft Corp. posted its biggest sales gain in 2 1/2 years, and AT&T Inc., United Parcel Service Inc. and EBay Inc. also beat earnings estimates.

President Barack Obama signed an extension for jobless benefits into law yesterday, granting $34 billion of extra payments to the unemployed.

Futures on the CME Group Inc. exchange showed a 33 percent chance policy makers will boost the target lending rate for overnight bank loans at least a quarter-percentage point by April, compared with a 55 percent likelihood a month ago.

The Treasury will auction $38 billion in two-year notes, $37 billion of five-year debt and $29 billion in seven-year securities over three days next week starting July 27.

To contact the reporter on this story: Susanne Walker in New York at swalker33@bloomberg.net

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