Treasury Yield Curve Almost Flattest Since October on Fed’s Economic View

Treasuries rose, pushing yields on two- and 10-year notes toward record lows reached yesterday, as stocks tumbled a day after the Federal Reserve offered a dimmer view of the economy than it did in June.

The extra yield Treasury investors get to hold 10-year notes instead of two-year debt was the narrowest in a year as investors worried the European debt crisis would grow before today’s $24 billion auction of the securities, the second of three note and bond sales this week totaling $72 billion. Stocks fell as Paris-based lender Societe Generale SA retreated 16 percent and France’s borrowing costs rose.

“We are seeing a yield grab,” said Larry Milstein, managing director in New York of government and agency debt trading at R.W. Pressprich & Co., a fixed-income broker and dealer for institutional investors. “By locking the front end of the curve for two years, the Fed wants to push investors further out the curve and push them into risk, and that is what we are seeing.”

Yields on 10-year notes decreased 13 basis points, or 0.13 percentage point, to 2.12 percent at 11:31 a.m. in New York, according to Bloomberg Bond Trader prices. The 3.125 percent securities maturing in May 2021 rose 1 6/32, or $11.88 per $1,000 face amount, to 108 27/32.

The Standard & Poor’s 500 Index fell 3.7 percent after the gauge’s biggest jump in more than two years yesterday.

Record Fall

The 10-year note yields slid yesterday to an all-time low of 2.0346 percent after the Fed’s statement before paring their drop. Two-year note yields dropped three basis points today to 0.16 percent after falling yesterday to a record low 0.1568 percent.

Investors demand about 88 basis points of extra yield to buy 10-year French debt rather than German bunds.

The difference in yield between two- and 10-year Treasuries was 1.95 percentage points, the least on a closing basis August 2010. A narrower yield difference, or flatter curve, indicates investors are betting on lower growth and inflation. The difference widens as investors demand higher compensation to buy longer-term securities on concern the economy may strengthen, spurring inflation.

‘Grinding Lower’

“Until we have some resolution in stocks or some notion that Europe is contained there will be very limited room for Treasuries to sell off,” said Christian Cooper, head of U.S. dollar derivatives trading in New York at Jefferies Group Inc., one of the 20 primary dealers that trade with the Fed. “We are grinding lower and lower in yields, and the inevitable questions arise about are we Japan and if the yield curve should be this flat.”

The extra yield 10-year securities offer over the Fed’s target rate for overnight lending between banks shrank to 1.92 percentage points, the least since January 2009.

Demand increased at a $32 billion sale of three-year Treasuries yesterday, the first note auction since S&P cut the U.S. debt rating on Aug. 5. The yield was 0.50 percent, the lowest since the beginning of records in May 1981. Investors bid for 3.29 times the amount offered, the most since May for these monthly auctions.

The 10-year securities scheduled for sale today yielded 2.305 percent in pre-auction trading, compared with 2.918 percent the last time the notes were sold July 13.

Fed Role

“The dramatic change in sentiment, with the Fed guaranteeing low rates, provides some support,” said Christopher Bury, co-head of fixed-income rates at Jefferies Group Inc., one of the 20 primary dealers obliged to participate in government auctions. “The near-term risk is that we’ve come too far too fast and we could get a concession into the auctions.”

Investors submitted orders for 3.17 times the amount of debt offered last month, compared with the average of 3.11 for the past 10 auctions.

Indirect bidders, the group that includes foreign central banks, bought 42 percent of the debt, the least since October. Direct bidders, non-primary dealers buying for their own accounts, purchased 13.9 percent. A $16 billion 30-year auction tomorrow will complete this week’s note and bond sales.

Treasuries advanced yesterday after Fed officials promised to keep their benchmark at a historic low at least through mid- 2013 to help revive economic growth. Policy makers cut the target rate to a range of zero to 0.25 percent in 2008.

Cash Flows

U.S. debt rallied as the central bank said U.S. economic growth is “considerably slower” than anticipated.

“We had a good influx of cash into the market yesterday,” said Paul Horrmann, a broker in New York at Tradition Asiel Securities Inc., an interdealer broker. “Yields responded pretty aggressively. We’ve had a back-up from the lows. The Fed is saying they expect a depressed labor market and a tough road ahead so they need to have low rates to spur growth.”

Fed Chairman Ben S. Bernanke’s plan to hold interest rates at virtually zero provoked the most opposition among voting policy makers in 18 years as central bank consensus frayed. Three of his colleagues dissented from the decision to apply a specific date to the Fed’s low rate pledge for the first time.

Societe Generale posted a record decline and led a drop in French banking shares as the cost of insuring the country’s government bonds increased. UniCredit SpA, Italy’s biggest bank, paced a retreat in Italian banks after the country’s credit- default swaps widened.

The bank’s shares slumped as much as 23 percent and were down 16 percent at 21.89 euros in Paris. Credit-default swaps on the bank rose 29 basis points to a record 299 basis points.

Treasuries have returned 6.8 percent this year, according to indexes complied by Bloomberg and the European Federation of Financial Analysts Societies. Japan’s government bonds have gained 1.1 percent, while German bunds have advanced 4.3 percent, the indexes show.

To contact the reporters on this story: Susanne Walker in New York at swalker33@bloomberg.net; Cordell Eddings in New York at ceddings@bloomberg.net;

To contact the editor responsible for this story: Robert Burgess at bburgess@bloomberg.net

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