U.S. Two-Year Yield Hits Record Low as Slow Growth, Europe May Spur Fed

Treasuries rose, pushing the two-year note yield to a record low, as signs of stalled economic growth in the U.S. and a widening sovereign debt crisis in Europe boosted demand for the perceived safety of U.S. debt. Standard & Poor's cut the nation's AAA rating to AA+ after markets closed yesterday.

The yield on the 30-year bond fell 27 basis points, the largest weekly drop since December 2008, after President Barack Obama signed legislation to raise the debt limit by at least $2.1 trillion, averting a first ever U.S. financial default. Growth concern was tempered yesterday when a report yesterday showed the U.S added more jobs than forecast in July. Federal Reserve policy makers meet Aug. 9 amid speculation they may consider additional steps to bolster the U.S. economy, such as a third debt-buying program, known as quantitative easing.

“A QE3 program is probably likely,” said James Camp, managing director of fixed-income in St. Petersburg, Florida at Eagle Asset Management Inc, which manages $19.5 billion. “The problems in the euro zone will continue to buoy U.S. Treasuries. I don’t see any real headwinds to the Treasury market for the next handful of trading sessions.”

Yields on 10-year notes dropped 24 basis points, or 0.24 percentage point, to 2.56 percent on the week, according to Bloomberg Bond Trader prices. The 3.125 percent securities maturing in May 2021 rose 2 2/32, or $20.63 per $1,000 face amount, to 104 28/32.

Yield Record

The two-year note yield dropped seven basis points. It touched a record 0.2527 percent on Aug. 4. The 30-year bond yield touched 3.62 percent yesterday, the lowest since September 2010 and the 10-year note yield touched 2.33 percent yesterday, the lease since October 2010.

After markets closed S&P cut the U.S. from AAA, citing the failure by lawmakers to cut spending enough to reduce record deficits. “The downgrade reflects our opinion that the fiscal consolidation plan that Congress and the Administration recently agreed to falls short of what, in our view, would be necessary to stabilize the government’s medium-term debt dynamics,” S&P said in a statement.

Treasuries have returned 5.3 percent this year, while global governments returned 3 percent, according to Bank of America Merrill Lynch’s data.

“People are trying to avoid risk,” said Kris Kowal, who oversees $4 billion in assets as managing director and chief investment officer, fixed-income at DuPont Capital Management in Wilmington, Delaware.

Jobs Data

Treasuries dropped yesterday, trimming the weekly rally, after the Labor Department said the U.S. added 117,000 jobs last month. July payrolls rose after a 46,000 increase in June that was larger than earlier estimated, the Labor Department said yesterday in Washington. The median estimate in a Bloomberg News survey called for a gain of 85,000. The jobless rate dropped to 9.1 percent as discouraged workers left the labor force. Average hourly earnings climbed 0.4 percent.

“The jobs report gives us a break from the double-dip- recession fears,” Camp of Eagle Asset Management said.

Treasuries gained after a report on Aug. 1 showed The Institute for Supply Management’s factory index fell to 50.9 in July from 55.3 the prior month, fueling speculation the pace of the U.S. economy has slowed. A report July 29 indicated GDP grew at a less than forecast 1.3 percent annual rate from April through June after a 0.4 percent first-quarter gain that was less than previously estimated.

“The data remains soft and the environment remains uncertain,” said Chris Ahrens, head U.S. rates strategist in Stamford, Connecticut, at UBS AG, one of the 20 primary dealers that trade with the Fed. “People are seeking a safe harbor in Treasuries.”

Fed Target

The Fed next week is forecast to leave its target interest rate unchanged at zero to 0.25 percent where it has been since December 2008. Of 12 Fed staff forecasts since the beginning of 2010, seven have been downward revisions to the near-term outlook, according to minutes of Federal Open Market Committee meetings. This year, the outlook was raised in January and lowered three times since.

The term premium for Treasuries, a financial model created by Fed economists to measure the extra yield demanded for moving out the yield curve as a proxy for where the yield on the 10- year note should be, was at negative 0.2 percent yesterday, almost the negative 0.28 percent it reached Aug. 4. The measure suggests Treasuries are the most expensive since Nov. 10, 2010, the day the Fed announced the amount of U.S. debt it would buy in the next month as part of its $600 billion quantitative easing program.

Europe Crisis

Treasuries also rose as the European Central Bank signaled Aug. 4 it resumed bond purchases as it offered banks more cash to stop the debt crisis from engulfing Italy and Spain. The ECB action follows the unexpected interest rate cut by Switzerland’s central bank and Japan’s foreign exchange market intervention to address economic distress from a weak dollar.

While yields on Italian and Spanish debt fell yesterday, borrowing costs have surged since a July 21 European Union summit aimed at heading off contagion from Europe’s debt crisis to the euro zone’s third- and fourth-largest economies. Italian 10-year bond yields are up 76 basis points since the summit, while Spanish yields are up 33 basis points.

“Given some of the contagion fears in Europe, the U.S. is still a safe haven,” said Andy Richman, who oversees $10 billion as a strategist in Palm Beach, Florida for SunTrust Bank’s private wealth management division.

Rates on Treasury six-month bills due Aug. 11 were at 0.01 percent yesterday. The rate rose to 0.26 percent on July 29, the highest since they were issued in February, on concern Congress wouldn’t raise the debt limit by the Aug. 2 deadline.

One-month bill rates dropped to 0.005 percent, down from 0.1825 percent on July 29. Rates on three-month bills touched negative 0.005 percent yesterday.

The U.S. will sell $72 billion in notes and bonds next week. It will auction $32 billion of three-year notes, $24 billion of 10-year debt and $16 billion of 30-year bonds on three consecutive days beginning Aug. 9. The amounts are the same as the grouping of auctions of these maturities sold in May.

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

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