Treasury Bonds Decline Amid Debt Debate; Note Increase on Refuge Appeal

Treasury 30-year bonds declined as concern that the U.S. is closer to losing its top credit rating and a report showed that consumer prices excluding food and energy increased for a second month.

The bonds slid for a third day after Standard & Poor’s followed Moody’s Investors Service in saying it may cut the AAA rating of the U.S. as lawmakers hold debt reduction talks. The government has said it has until Aug. 2 before its ability to make payment on $14.3 trillion of debt expires. Notes gained as investors continued to seek a refuge in shorter-maturity debt from Europe’s debt crisis.

“It really comes down to the people in Washington,” said Charles Comiskey, head of Treasury trading at Bank of Nova Scotia in New York. “It’s going to go right down to the end. The economic data is a sideshow. It shows the U.S. economy is behaving weakly and that’s already in the prices.”

The 30-year yield gained 2 basis points to 4.28 percent at 12:40 p.m. in New York, according to Bloomberg Bond Trader prices. The 4.375 percent note due May 2041 fell 13/32, or $4.06 per $1,000 face amount, to 101 19/16.

Benchmark 10-year yields fell 2 basis points to 2.94 percent as regulators said eight European banks faced a $3.5 billion capital shortfall.

The U.S. House plans a vote next week on a measure that would raise the government’s debt limit by $2.4 trillion, cut spending, cap government expenditures and propose a balanced- budget constitutional amendment, Republican lawmakers Sean Duffy and Billy Long said. Duffy, of Wisconsin, and Long, of Missouri, described discussions in a closed-door meeting of House Republicans on Capitol Hill.

Gradual Approach

President Barack Obama downplayed the vote, saying in a press conference in Washington today that he’s “ready to move” when he is shown a “serious plan.”

Pacific Investment Management Co.’s Bill Gross, manager of the world’s biggest bond fund, said lawmakers “don’t get” the long-term implications of the debate over how to lower the deficit. Lawmakers “need to approach it gradually” when it comes to cutting spending, Gross said on Bloomberg Television’s “Surveillance Midday” during an interview with Tom Keene. You can’t cut billions over a year or two and “expect the economy to survive,” he said.

Longer-maturity debt will be hurt more if the credit rating of the U.S. is downgraded, Gross said.

Consumer Prices

The consumer-price index decreased 0.2 percent, compared with the 0.1 percent drop median forecast of economists surveyed by Bloomberg News, figures from the Labor Department showed today in Washington. The so-called core measure, which excludes more volatile food and energy costs, climbed 0.3 percent for a second month, more than forecast and the biggest back-to-back gain in three years.

“The trend is for slightly rising inflation risks so it implies higher yields” on the 30-year bond, said Guy LeBas, chief fixed-income strategist at Janney Montgomery Scott LLC in Philadelphia. “ The market is looking at core CPI.”

The difference between yields on 10-year notes and Treasury Inflation Protected Securities, a gauge of trader expectations for consumer prices over the life of the debt, has declined to 2.27 percentage points from this year’s high of 2.67 percentage points in April. The 10-year average is 2.11 percentage points.

“I’m not concerned about inflation until the Fed tells me to be concerned,” said Ray Remy, head of fixed income in New York at Daiwa Capital Markets America Inc., one of 20 primary dealers that trade directly with the Fed. “The economy is growing, but growing slowly.”

Slowing Growth

Manufacturing in the New York region unexpectedly contracted for a second straight month in July as orders shrank at a faster pace. The Federal Reserve Bank of New York’s general economic index rose to minus 3.8, less than the most pessimistic forecast in a Bloomberg News survey, from minus 7.8 the prior month. The median forecast called for an index of 5. Readings greater than zero signal expansion in the so-called Empire State Index, which covers New York, northern New Jersey and southern Connecticut.

Industrial production in the U.S. rose by 0.2 percent, less than the 0.3 percent forecast in June, restrained by declines in the output of autos and business equipment. It followed a revised 0.1 percent decrease the prior month that was initially reported as a gain, figures from the Fed showed today.

Refuge Appeal

Treasuries are still headed for a second weekly gain even as the U.S. sold $66 billion in debt this week, including $32 billion in three-year notes on July 12, $21 billion in 10-year notes the next day and $13 billion 30-year bonds yesterday. The auction yesterday sold at a yield of 4.198 percent, lower than the 4.209 percent forecast in a Bloomberg News survey of 10 primary dealers.

The 10-year yield is down seven nine points as investors sought the safest assets amid concern that the U.S. recovery is struggling and the European sovereign-debt crisis is worsening.

German government securities climbed, while Greek and Irish two-year yields surged to a record before the publication of stress tests on European banks.

Eight banks failed the European Union stress tests after regulators said they had a combined capital shortfall of 2.5 billion euros ($3.5 billion), according to assessments by the European Banking Authority. All banks tested in Italy, Germany, France, the U.K. and Ireland passed, the lenders said today.

“Safe havens like bunds and Treasuries still remain well supported by the whole debt crisis and also this soft patch in U.S. data,” said Michael Leister, a fixed-income analyst at WestLB AG in London.

To contact the reporter 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

3:56

July 15 (Bloomberg) -- Joseph Balestrino, a fixed-income market strategist at Federated Investors Inc., discusses the outlook for the U.S. debt ceiling and credit rating. Balestrino, speaking with Deirdre Bolton on Bloomberg Television's "InsideTrack," also talks about the Treasury market, deflation risk and the the prospects of another round of quantitative easing by the Federal Reserve. (Source: Bloomberg)