Treasuries Set for Best Year Since 2008

Treasuries advanced for a fourth day, capping their biggest annual return since 2008, as investors sought the refuge of U.S. government securities on concern Europe’s sovereign-debt crisis will worsen.

Bonds extended gains as Spain’s new government moved to increase taxes and reduce spending to tackle a larger-than- forecast budget deficit that’s twice the fiscal shortfall in Italy. Treasuries are set to beat stocks, commodities and the dollar for the year, even as reports signal the U.S. economy is recovering.

“On its own, rates would be significantly higher in the U.S., but we are not an island unto ourselves,” 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. “The exogenous impact from Europe is clearly keeping our rates much lower than they would be otherwise.”

The 10-year note yield (USGG10YR) fell two basis points, or 0.02 percentage point, to 1.88 percent as of 2:43 p.m. New York time, according to Bloomberg Bond Trader prices. It declined 15 basis points this week and lost 19 basis points in December. The 2 percent securities due in November 2021 rose 6/32 today, or $1.88 per $1,000 face amount, to 101 3/32. Their last four-day winning streak ended Nov. 17.

Thirty-year bond (USGG30YR) yields decreased one basis point to 2.89 percent today, and five-year note yields dropped five basis points to 0.83 percent.

Lower Volumes

Treasury market volumes have slid amid the Christmas and New Year’s holiday season. About $103 billion of Treasuries changed hands (ICPTVOL) today as of 2:01 p.m. through ICAP Plc, the world’s largest interdealer broker. About $109 billion changed hands yesterday. The 2011 daily average is $285 billion.

The Securities Industry and Financial Markets Association recommended that trading in Treasuries close at 2 p.m. in New York and remain shut on Jan. 2 in observance of New Year’s Eve and New Year’s Day.

The Federal Reserve said today it will purchase about $45 billion of Treasuries in January and sell about $44 billion in its program to lower borrowing costs by replacing $400 billion of shorter-term assets in its holdings with longer-term debt.

U.S. government debt returned 9.6 percent in 2011, according to Bank of America Merrill Lynch data, even after Standard & Poor’s cut the nation’s AAA rating on Aug. 5. German bunds also gained 9.6 percent, while Japanese bonds advanced 2.1 percent and U.S. corporate debt rallied 7.3 percent.

Record Low

Benchmark 10-year yields dropped to a record 1.67 percent on Sept. 23 amid the European debt turmoil. Two years of summits have failed to contain a crisis that has led to bailouts of Greece, Ireland and Portugal and now threatens Spain and Italy.

Luxembourg’s Jean-Claude Juncker, who leads the group of euro-area finance ministers, said economic growth in the 17- nation region “isn’t good.” He spoke on RTL Luxembourg radio.

Spain’s deficit this year will reach 8 percent of gross domestic product, requiring tax boosts of 6 billion euros and spending cuts of 8.9 billion euros, spokeswoman Soraya Saenz de Santamaria said at a press conference in Madrid.

“A year ago there was probably a greater expectation that rates would start to creep higher,” said Adam Brown, director of Treasury trading at Barclays Plc in New York, one of 21 primary dealers that trade with the Fed. “The economy, although it seems better and we’ve had some decent growth, is not growing strong enough that there’s no fear that it dips back down, especially with something like the European issue affecting it.”

A four-week bill sale on Dec. 20 drew bids (USB4WBC) for a record 9.07 times the amount offered even though rates on the securities were below zero in New York trading.

Foreign Central Banks

U.S. government securities rose in December even as Treasuries held in custody at the Fed for foreign central banks and other official investors fell by $68.9 billion, the biggest four-week drop on record, according to Fed data. The reduction came as the dollar strengthened, with the Dollar Index (DXY) increasing 2.3 percent in December.

“It’s not unlikely they are repatriating assets to shore up their own economies,” said Ian Lyngen, a government bond strategist at CRT Capital Group LLC in Stamford, Connecticut.

S&P Downgrade

S&P downgraded the U.S. rating this year for the first time, criticizing lawmakers for failing to cut spending enough to reduce budget deficits (FDEBTY) that exceed $1 trillion a year.

Treasuries still were some of the best assets to own in 2011. U.S. 30-year bonds returned 35 percent, the most since 2008, and Treasury Inflation Protected Securities gained 14 percent, the most since 2002, the Bank of America indexes show.

The difference (USGGBE10) 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, was 1.95 percentage points today. The average over the past decade is 2.13 percentage points.

Stocks have lost 6.8 percent this year after accounting for reinvested dividends, based on the MSCI All Country World Index (MXWD). The Dollar Index tracking the U.S. currency against six major counterparts rose 1.5 percent in 2011. The Standard & Poor’s GSCI Total Return Index (SPGSCITR) of commodities slipped 1 percent.

Growth in the world’s biggest economy will quicken to 2.1 percent in 2012 from 1.8 percent in 2011, a Bloomberg survey of banks and securities companies shows. U.S. jobless-benefit applications over the past month fell to a three-year low, data showed yesterday. The Institute for Supply Management-Chicago Inc. said its business barometer was at 62.5 this month, compared with a Bloomberg poll forecast of 61. Readings above 50 signal growth.

U.S. payrolls added 150,000 workers in December, after gaining 120,000 in November, according to another Bloomberg survey before the government reports the data on Jan. 6.

Treasury 10-year yields will advance to 2.66 percent by the end of 2012, according to a Bloomberg survey with the most recent forecasts given the heaviest weightings.

To contact the reporter on this story: Daniel Kruger in New York at dkruger1@bloomberg.net

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

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