Treasuries Gain as Concerns Over Europe's Fiscal Health Spur Safety Demand

Treasuries advanced, pushing 10-year yields down from the highest in almost a month, as stock-market losses and speculation that European banks will struggle to raise funds boosted demand for the safety of fixed income.

Longer-maturity bonds led the advance as the Stoxx Europe 600 Index lost 0.7 percent, snapping two days of gains. The Association of German Banks said yesterday the nation’s 10 largest lenders may need about 105 billion euros ($135 billion) in fresh capital, while the Wall Street Journal reported that July’s stress tests underestimated some banks’ holdings of potentially risky bonds. The Treasury is scheduled to sell a total of $67 billion in three-, 10- and 30-year debt this week.

“Any worries you hear about banks will cause some flight to quality and that may be supportive of Treasuries,” said Nick Stamenkovic, a fixed-income strategist at RIA Capital Markets Ltd. in Edinburgh. “We haven’t seen much of a follow through from the rally in stocks” last week, he said.

The yield on the 10-year note declined 5 basis points, or 0.05 percentage point, to 2.65 percent as of 6:32 a.m. in New York, according to BGCantor Market Data. The 2.625 percent security maturing in August 2020 rose 13/32, or $4.06 per $1,000 face amount, to 99 25/32. The two-year yield fell 2 basis points to 0.5 percent.

Benchmark yields reached 2.76 percent on Sept. 3, the highest since Aug. 10, and climbed 22 basis points in three days to Sept. 3 for the biggest gain since the period ended Dec. 22.

The 10-year yield may rise to 3 percent by year-end as investors judge that speculation about a new U.S. recession is misplaced, Stamenkovic said. The median of 73 analysts and strategists’ predictions compiled by Bloomberg is for the yield to increase to 3.1 percent in the fourth quarter.

Stress Tests

Europe’s recent stress tests of major banks understated some lenders’ holdings of risky government debt, the Journal said, citing its own analysis. Some European banks excluded certain nations’ debt from their totals, while others reduced amounts to account for short positions, according to the report published on the newspaper’s website yesterday. The European Union tested 91 lenders in July, giving 84 of them passing grades.

Treasuries have returned 7.7 percent in 2010 after losing 3.7 percent last year, according to Bank of America Merrill Lynch indexes, as investors sought the relative safety of so- called core government debt. German bunds have returned 8.9 percent, compared with a 1.9 percent gain in 2009.

Fed Stimulus

U.S. policy makers should consider more stimulus measures such as buying government bonds if warranted, the New York Times reported former Federal Reserve Governor Donald Kohn as saying.

Kohn said that real interest rates could start to rise if inflation expectations drop, and that the current economic rebound is likely to be slower than previous ones, according to the newspaper. Kohn, who retired from the Fed Sept. 1, was speaking in an interview, the Times said.

Futures trading on the CME Group exchange showed a 76 percent chance the Fed will keep the target rate for overnight bank lending in a range of zero to 0.25 percent at its December meeting, up from a 70 percent probability one month ago.

Gains in Treasuries were tempered on concern that President Barack Obama will boost spending to prevent a recession. Obama yesterday proposed spending at least $50 billion to rehabilitate the nation’s transportation infrastructure to help spur an economy that has lost jobs for three straight months. Obama has increased U.S. publicly traded debt to a record $8.18 trillion.

Jobless Claims

A report this week will probably show the number of Americans seeking jobless benefits fell last week. Initial jobless claims fell to 470,000 in the week ended Sept. 4, from 472,000 in the previous week, according to the median prediction of 34 economists surveyed by Bloomberg News before the Labor Department release scheduled for Sept. 9.

“Unless we face a really serious slowdown, yields should be close to a bottom,” said Luca Cazzulani, a senior fixed- income strategist at UniCredit SpA in Milan. Yields may stay “roughly sideways” until the middle of next year and then start rising to reflect possible policy tightening from 2012, he said.

The extra yield investors demand to hold 10-year U.S. notes over two-year debt was 2.16 percentage points. It reached 2.24 percentage points on Sept. 3, the highest since Aug. 11.

The government will sell $33 billion in three-year notes today, $21 billion in 10-year debt tomorrow and $13 billion in 30-year bonds on Sept. 9. The total of $67 billion is the smallest combination of the maturities since July 2009.

Consumer Prices

Treasuries that protect against rising consumer prices, the difference between short- and long-term interest rates, and so- called real yields show investors anticipate a 28 percent chance of deflation, according to London-based Barclays Plc. That’s down from 70 percent in the aftermath of the collapse of Lehman Brothers Holdings Inc. in 2008.

“There is more than a fair share of bearishness on the economy priced into the market,” said James Sarni, senior managing partner at Payden & Rygel in Los Angeles, which oversees $50 billion. “The fact is we are seeing growth, though slowly, and people are spending money slowly. Policy makers have shown they are willing to do a lot to spur growth.”

To contact the reporters on this story: Lukanyo Mnyanda in London at lmnyanda@bloomberg.net; Yasuhiko Seki in Tokyo at yseki5@bloomberg.net.

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