Treasuries Advance as Dudley Seeks to Ease Inflation Concern

Treasuries rose, recovering from the biggest two-day decline in almost two years, as two Federal Reserve regional bank presidents defended the central bank’s $600 billion asset purchase program after criticism from economists and politicians saying the program is inflationary.

Benchmark 10-year yields jumped 31 basis points during the previous two trading days, the most since a back-to-back surge of 33 basis points in January 2009. Boston’s Eric Rosengren said he expects the central bank to buy the entire amount in a bid to reduce unemployment. James Bullard of the St. Louis said the Fed would buy less than planned under quantitative easing only after a big improvement in the economy. The central bank bought $5.4 billion of Treasuries.

“We’ve seen people try to jump to the conclusion that the market is against QE2,” said John Briggs, a U.S. government bond strategist at Royal Bank of Scotland Plc’s RBS Securities unit in Stamford, Connecticut, one of 18 primary dealers that trade with the Fed. “It’s a counterbalance to some of the political-related comments we’ve been seeing. The success of QE2 will be judged over the course of three to six months in asset prices and growth and inflation, not in a week’s move.”

Yields on 10-year notes fell 12 basis points to 2.84 percent as of 5:10 p.m. in New York, according to BGCantor Market Data. The 2.625 percent security due in November 2020 advanced 1, or $10 per $1,000 face amount, to 98 4/32.

Volatile Trade

Thirty-year notes yields fell 15 basis points to 4.27 percent, after touching 4.25 percent, the sharpest drop since May 6. Two-year note yields declined four basis points to 0.5 percent.

Volatility in the Treasury market has picked up. Merrill Lynch & Co.’s MOVE index, which measure price swings in Treasuries based on prices of over-the-counter options maturing in two to 30 years, rose to 103.9 yesterday, the highest since Sept. 13

“It’s protection of profits,” RBS Securities’ Briggs said. “It’s risk aversion at year-end. Everybody was long Treasuries for this position, so when the market failed to move to lower yields on the announcement, we started seeing profit- talking.”

Bullard joined a chorus of Fed governors who have expressed their views on the second round of Fed purchases. He said that the central bank will review bond buying as economic data come in and that the first order of business is avoiding deflation, in an interview on Bloomberg Radio’s “The Hays Advantage,” with Kathleen Hays.

Yield Analysis

An increase in 10-year Treasury yields during the past two weeks reflects stronger economic data, and the Fed’s unconventional monetary policy seems to be working, Bullard said.

Another Fed governor expressed views on the program.

“Given my forecast, I fully anticipate we will purchase the entire amount,” Rosengren said today in an interview with Bloomberg News. “Certainly if the economy were to weaken substantially and further disinflation were to occur, we should take more action,” and officials could also make “adjustments” if the economy turned out to be much stronger than expected, he said.

Fed Vice Chairman Janet Yellen earlier told the Wall Street Journal the central bank isn’t trying to weaken the dollar or push the inflation rate higher than 2 percent.

Dudley’s Case

New York Fed President William Dudley said the central bank’s bond purchases won’t cause an inflation problem. Dudley was responding to criticism that the Fed’s plan to add $600 billion to the economy by buying Treasuries will lead to higher prices for consumers.

“People do not understand clearly” that “we can have an enlarged balance sheet and not have a long-term inflation problem,” he said in an interview with CNBC.

The central bank today bought $5.4 billion of Treasuries maturing from July 2012 to May 2013, according to its website.

Global demand for U.S. stocks, bonds and other financial assets fell in September from a month earlier, the Treasury Department reported. Net buying of long-term equities, notes and bonds totaled $81.0 billion during the month compared with net buying of $128.7 billion in August, according to data issued today in Washington.

The producer price index climbed 0.4 percent in October from the prior month, Labor Department figures showed today in Washington. Economists projected a 0.8 percent rise, according to the median estimate in a Bloomberg News survey. The so-called core measure, which excludes volatile food and energy costs, decreased 0.6 percent, the most since July 2006.

“The PPI is telling you there’s very little inflation in the system,” said Thomas L. di Galoma, head of U.S. rates trading at Guggenheim Capital Markets LLC, a New-York based brokerage for institutional investors. “That’s the underlying theme and that’s why the Fed is commencing this QE2 program.”

To contact the reporters on this story: Susanne Walker in New York at swalker33@bloomberg.net To contact the editor responsible for this story: Dave Liedtka at dliedtka@bloomberg.net

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