Treasury Yields Tumble Amid Concern Worldwide Economic Growth Is Slowing

Treasuries surged, pushing yields to record lows, as investors sought a refuge in the world’s safest securities on concern global growth is slowing and speculation inflation will remain subdued.

U.S. government debt was on pace for the best monthly returns since December 2008 a week after the Federal Reserve said it would keep borrowing costs unchanged until at least mid-2013. Treasuries have returned 1.8 percent since Standard & Poor’s lowered the U.S. credit rating for the first time on Aug. 5 and are up 2.9 percent this month. Bank of America Merrill Lynch’s Global Government Bond Index, which excludes the U.S., has increased 1.7 percent in August.

“The only place to hide is in the U.S.,” said James Camp, managing director of fixed income in St. Petersburg, Florida, at Eagle Asset Management Inc., which manages $19.5 billion. “Rates are going to test the lows. It’s the anemic or worse economic growth, a benign inflation environment and catastrophe in Europe.”

Yields on 10-year notes dropped 10 basis points, or 0.10 percentage point, to 2.06 percent at 5:13 p.m. in New York, according to Bloomberg Bond Trader prices. The 2.125 percent securities due in August 2021 rose 29/32, or $9.06 per $1,000 face amount, to 100 18/32. The yields touched the record low of 1.9735 percent, dropping below 2 percent for the first time.

Drop in Stocks

The S&P 500 Index tumbled 4.5 percent. Crude oil for September delivery dropped 6.9 percent. The Dollar Index, which IntercontinentalExchange Inc. uses to gauge the greenback against a basket of currencies of six major U.S. trading partners, rallied the most in two weeks on a bid for safety.

The 2.9 percent return on Treasuries in August would be the biggest since U.S. debt increased 3.5 percent at the depths of the financial crisis in December 2008, according to Bank of America Merrill Lynch’s U.S. Treasury Master Index.

“It’s capitulation that growth will be subpar,” said Ira Jersey, an interest-rate strategist in New York at Credit Suisse Group AG, one of 20 primary dealers that trade directly with the U.S. central bank. “In 2008, there was optimism that we would have growth by now.”

The previous record low for the 10-year note yield was set on Aug. 9 as the Fed committed to leaving benchmark rates unchanged after S&P cut the U.S. credit rating to AA+ from AAA four days earlier, citing the political failure to cut U.S. deficits. Before that, the 10-year yield slid to a record in December 2008 amid the worst economy since World War II, credit- market losses exceeding $1 trillion and the biggest drop in the S&P 500 Index (SPX) since 1931.

Treasury Yields

A gain of more than two points in 30-year bonds today pushed yields down 14 basis points to 3.42 percent. Five- and seven-year note yields touched record lows of 0.79 percent and 1.31 percent. Two-year notes yielded 0.19 percent.

U.S. Treasury yields are about 82 basis points lower than those of other global government bonds, according to Bank of America Merrill Lynch indexes. Interest rates on American bonds are lower today than on most of the countries with AAA ratings by S&P, and the Treasury recently financed its outstanding debt at the lowest cost ever.

“There has been a realization that irrespective of what S&P says or the credibility they do or do not have, in a crisis investors still want U.S. Treasuries,” said Larry Milstein, managing director of government and agency debt trading in New York at R.W. Pressprich & Co., a fixed-income broker and dealer for institutional investors. “We are in a market where you don’t want to be short Treasuries. You want to buy any weakness until proven otherwise.” A short is a bet that the price of a security will fall.

Debt Returns

Fixed-income securities from the U.S. to Europe and Asia have returned 1.6 percent on average in August, the most since gaining 1.7 percent in the same month of 2010, according to Bank of America Merrill Lynch’s Global Broad Market Index.

Yields as measured by the index, which covers more than 19,000 government, corporate, asset-backed and other types of securities, have fallen to 2.25 percent, from this year’s high of 3.03 percent in April.

Consumer prices excluding food and energy increased 0.2 percent last month, the lowest level since April, the Labor Department reported today. First-time jobless claims climbed by 9,000 to 408,000 in the week ended Aug. 13, the highest in a month, the Labor Department also said.

Philadelphia Manufacturing

Manufacturing in the Philadelphia region unexpectedly contracted in August by the most in more than two years as orders plunged and factories shed workers. The Philadelphia Fed’s general economic index plunged to minus 30.7 this month, the lowest since March 2009, from 3.2 in July. Readings less than zero signal contraction in the area covering eastern Pennsylvania, southern New Jersey and Delaware.

“The market is connected to the economic outlook, which continues to deteriorate,” said Mark MacQueen, a partner in Austin, Texas, at Sage Advisory Services Ltd., which oversees $9.5 billion. “It’s a long-term pain situation here.”

Gross domestic product increased in the second quarter at a 1.3 percent annual rate following a 0.4 percent gain in the prior quarter that was less than earlier estimated, Commerce Department figures showed July 29.

The extra yield Treasury investors get to hold 30-year bonds instead of two-year notes fell to 327 basis points, the narrowest on a closing basis since September.

‘Marked Down’

“Realizing that global economic growth will continue to be marked down compared to what people were expecting, that we are seeing no inflation and that central banks are keeping rates low, investors have every incentive to grab yield wherever they can, and this means buying further out the Treasury curve,” said Bulent Baygun, head of interest-rate strategy in New York at BNP Paribas SA, a primary dealer.

Even Bill Gross, who runs the world’s biggest bond fund at Pacific Investment Management Co., has been building his holdings of U.S. government debt since eliminating the securities from his $245.5 billion Total Return Fund in February. He increased the securities to 10 percent of the fund’s assets last month. Gross had said that Treasuries “have little value” because of the nation’s growing debt burden and inflation-adjusted yields below zero.

“Recession likely as markets recognize impotency of policymakers,” Gross said today via Twitter.

The difference between the yield on benchmark 10-year notes and the year-over-year consumer price index, known as the real yield, touched negative 1.59 percentage points today, the biggest negative gap since July 2008. The spread has been negative since May. It touched 1.74 percent in January as the yield on the 10-year reached 3.5 percent.

Disney Debt

The drop in U.S. government bond yields has encouraged corporations to tap the fixed-income market. Walt Disney Co. (DIS) is taking advantage of demand for the longest maturity debt with its first 30-year bond sale in almost a decade after the Fed pledged to hold interest rates at record lows through at least mid-2013.

The world’s biggest theme-park operator sold $350 million of 4.375 percent, 30-year bonds yesterday, joining AT&T Inc. and Warren Buffett’s Burlington Northern Santa Fe, which had similar-maturity offerings in the past week, according to data compiled by Bloomberg. The average investment-grade bond maturity has climbed to 14 years since the Fed’s pledge on Aug. 9, from nine years in the rest of 2011.

The difference between yields on 10-year Treasuries and Treasury Inflation Protected Securities shrank to 2.08 percentage points, the narrowest since November. The so-called break-even rate, reflecting investor expectations for inflation during the next decade, widened to as much as 2.67 percentage points in April.

TIPS Auction

Today’s offering of U.S. five-year TIPS yielded negative 0.825 percent, compared with negative 0.180 percent at the auction of the securities on April 21. Investors bid for 2.49 times the amount of debt offered, versus the average of 2.61 for the past 10 auctions. Indirect bidders, the investor class that includes foreign central banks, bought 47.2 percent, versus the 10-sale average of 35.5 percent. Direct bidders bought a record high 17.1 percent.

The Treasury announced that it will sell $35 billion in two-year notes, the same amount of five-year debt and $29 billion of seven-year notes in auctions beginning Aug. 23. The amounts are the same as last month’s offerings.

New York Fed President William C. Dudley said the central bank’s commitment on Aug. 9 to keep its benchmark interest rate near zero through at least mid-2013 should help spur growth.

Dudley’s View

After the Fed’s pledge, “market interest rates generally moved lower, which should help provide some additional support for economic activity and jobs,” Dudley said today in Newark, New Jersey. “I would note, however, that conditions remain unsettled and the equity market in particular has been quite volatile recently.”

Fed Chairman Ben S. Bernanke may announce policy intentions at a conference in Jackson Hole, Wyoming, on Aug. 26.

In response to audience questions after his address, Dudley said the central bank always keeps an eye on the performance of U.S. and foreign banks, not monitoring one group more than the other. The Fed is “always scrutinizing” domestic and foreign banks in terms of capital levels, Dudley said.

U.S. regulators are stepping up scrutiny of American operations of Europe’s largest banks on concern the euro region’s sovereign-debt crisis may lead to funding problems, the Wall Street Journal reported. The New York Fed has been holding talks with the lenders and sought information about their access to funds, said the newspaper, citing people it didn’t identify.

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: Dave Liedtka at dliedtka@bloomberg.net

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