Treasury 10-Year Yield Drops to 16-Month Low as Stocks Tumble on Economy

Treasury 10-year notes rose, pushing the yield to a 16-month low, as stocks tumbled a day after the Federal Reserve said the U.S. recovery is slowing.

The government sold $24 billion of the benchmark debt at the lowest yield since January 2009 in the second of three note and bond sales this week totaling $74 billion. Two-year note yields touched a record low following the central bank’s decision to reinvest principal payments on mortgage assets it holds into U.S. debt to support the economy.

“All we’ve seen is buying of Treasuries,” said Suvrat Prakash, an interest-rate strategist in New York at BNP Paribas SA, one of the 18 primary dealers required to bid at Treasury auctions. “People aren’t looking to sell. They either stop buying and rest or keep chasing yield.”

The yield on the two-year note fell 1 basis point, or 0.01 percentage point, to 0.51 percent at 4:01 p.m. in New York, according to BGCantor Market Data. The price of the 0.625 percent security maturing in July 2012 increased 1/32, or 31 cents per $1,000 face amount, to 100 7/32.

The two-year note yield dropped earlier to 0.4892 percent, the lowest on record. The current 10-year note yield decreased 8 basis points to 2.68 percent after falling to 2.6797 percent, the lowest level since April 2009.

Stocks dropped on the economic outlook, pushing the Standard & Poor’s 500 Index down 2.8 percent. Crude oil for September delivery fell 3.2 percent to $77.65 a barrel in New York. The dollar rallied the most against the euro in 19 months on increased refuge demand.

Flatter Curve

The difference between 10- and 2-year yields narrowed for a fifth day, shrinking to 2.18 percentage points, indicating the flattest yield curve on a closing basis since April 2009. Over the past decade the spread has averaged 1.27 percentage points.

The extra yield that investors demand for 30-year bonds compared with 10-year debt widened to 1.25 percentage points, the most since the Treasury began regularly scheduled sales of the longer-dated securities in 1977.

Ten-year yields falling below resistance at 2.78 percent “leaves a lot of room for yields to fall further,” Jim Vogel, head of agency-debt research at FTN Financial in Memphis, Tennessee, wrote in a note to clients.

The Treasury yield curve indicates a 15.5 percent chance the economy will be in recession next July, up from 12.4 percent odds in June, wrote Joseph G. Haubrich and Timothy Bianco, researchers at the Cleveland Fed, in a note.

Portfolio Floor

At the Fed’s meeting yesterday, central bankers adopted a $2.05 trillion floor for their securities portfolio, pivoting toward a quantitative target for monetary policy.

Officials directed the New York Fed’s trading desk to reinvest maturing agency and mortgage-backed securities in Treasuries to keep U.S. debt yields and mortgage costs low and prevent monetary stimulus from shrinking further.

“The pace of recovery in output and employment has slowed in recent months,” the Federal Open Market Committee said in its statement. “Measures of underlying inflation have trended lower in recent quarters.”

The central bank plans to buy about $18 billion of Treasury debt and Treasury Inflation Protected Securities through mid- September, the New York Fed said in a statement today.

The Fed will probably purchase $300 billion to $325 billion of Treasuries in the next year, Ajay Rajadhyaksha and Dean Maki of Barclays Plc in New York wrote in an e-mail note to clients. The central bank bought $300 billion of government debt from March to October 2009 to bring down borrowing costs.

Purchases will be skewed toward intermediate maturities because rates on short-term notes are already low, according to Barclays, a primary dealer.

‘Seen as Helpful’

“They wanted to do something that is seen as helpful but not market-disruptive,” said Ira Jersey, a strategist in New York at Credit Suisse Group AG, another primary dealer.

The rate that London-based banks say they charge for three- month loans in dollars fell the most in almost a year.

The London interbank offered rate, or Libor, for such loans dropped 1.3 basis points, or 0.013 percentage point, to 0.384 percent, the British Bankers’ Association said.

At the government’s auction of 10-year notes, the securities drew a yield of 2.730 percent, compared with the average forecast of 2.747 percent in a Bloomberg News survey of 8 of the Fed’s 18 primary dealers. The bid-to-cover ratio, which gauges demand by comparing total bids with the amount of securities offered, was 3.04, compared with an average of 3.06 for the previous 10 sales.

Treasury Returns

Ten-year notes have returned 11.3 percent this year, outperforming the 7.1 percent gain for the broader Treasury market, according to Bank of America Merrill Lynch indexes.

The Treasury sold $34 billion in three-year debt yesterday at a yield of 0.844 percent, the lowest on record in an auction of the security. The government will sell $16 billion of 30-year bonds tomorrow.

The U.S. government posted a smaller budget deficit in July compared with the same month last year, helped by a gain in corporate tax revenue.

The excess of spending over revenue totaled $165 billion last month following a shortfall of $180.7 billion in July 2009, the Treasury reported. The gap for the fiscal year that started in October was $1.17 trillion, compared with $1.27 trillion last year at the same time.

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

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