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Treasury Five-, Seven-Year Notes Lead Gains Amid Fed Bets

Treasury notes rose for the first time in four days as U.S. job growth slowed more than forecast, fueling bets the Federal Reserve will add more stimulus to the economy through bond purchases as soon as next week.

Five- and seven-year notes led gains as traders speculated mortgage investors will look to Treasuries as a hedge with the Fed likely to increase purchases of similar-maturity housing bonds through so-called quantitative easing. Employers added 96,000 positions in August, versus a revised 141,000 increase in July. Fed Chairman Ben S. Bernanke said last week the central bank stands ready to provide additional support, citing unemployment as a “grave concern.” He has also pledged to keep borrowing costs low into 2014.

“These numbers will give the Federal Open Market Committee and Bernanke the ammunition they need to initiate another QE and to extend the language into 2015,” said Paul Montaquila, head of fixed-income trading at Bank of The West in San Ramon, California. “Both QE and an extension of the language are without question on the table for the September meeting. These are dismal job numbers.”

The benchmark 10-year yield declined one basis point, or 0.01 percentage point, to 1.67 percent at 5 p.m. in New York. It touched 1.74 percent, the highest level since Aug. 22, before the jobs data. The price of the 1.625 percent note due in August 2022 rose 3/32, or 94 cents per $1,000 face amount, to 99 19/32. The yield increased 12 basis points this week.

U.S. five-year yields dropped three basis points to 0.64 percent, and seven-year note yields fell three basis points to 1.09 percent.

Inflation Sensitivity

Thirty-year bond yields fell as much as seven basis points to 2.73 percent before trading at 2.83 percent, up three basis points. Quantitative easing may lead to higher inflation, and the securities, because of their long maturity, are more sensitive to inflation than shorter-term Treasuries.

The policy-setting Federal Open Market Committee will meet Sept. 12-13. The central bank bought $2.3 trillion of Treasury and mortgage-related debt from 2008 to 2011 in two rounds of purchases. It also has kept its benchmark rate at zero to 0.25 percent since December 2008.

“QE is coming next week,” said Sean Murphy, a trader at Societe Generale in New York, one of the 21 primary dealers that trade with the Fed. “They’ll be buying mortgages or announcing some kind of mortgage-buying program. What we’re seeing is buyers of fives and sevens because the life of a mortgage averages out to that area.”

Fannie Mae

A measure of relative yields on Fannie Mae and Freddie Mac mortgage securities that guide home-loan rates tumbled to the lowest in five years. A Bloomberg index of yields on Fannie Mae- guaranteed mortgage bonds trading closest to face value fell about six basis points to 114 basis points. It was the narrowest spread since 2007.

Traders increased bets inflation will rise. The difference between yields on conventional 10-year U.S. notes and comparable Treasury Inflation-Protected Securities widened to 2.37 percentage points, the most in five months. It represents the bond market’s expectations for the average rate of inflation during the life of the debt. The average gap in 2012 is 2.19 percentage points.

Treasuries fell yesterday as demand for refuge weakened when the European Central Bank announced a program to buy euro- area government bonds to contain the region’s debt crisis. ECB President Mario Draghi announced the unlimited purchase plan to regain control of interest rates in the region.

Political Issue

The U.S. jobless rate decreased to 8.1 percent, staying above 8 percent for a 43rd month. Economists in a Bloomberg News survey had forecast the report would show the U.S. added 130,000 jobs, versus a previously reported 163,000 in July, and that the jobless rate remained at 8.3 percent.

The payrolls data came two months before the U.S. presidential election. Employment and the economy are central themes in the campaign, with President Barack Obama and Republican challenger Mitt Romney each trying to convince voters they can best energize the expansion and create jobs.

“It’s the No. 1 topic going into the election,” said Chris Ahrens, an interest-rate strategist in Stamford, Connecticut, at the primary dealer UBS AG. “The sense in the market is that the central banks are on the move and are trying to be as supportive to the economic environment as possible. The bar is low for the Fed to institute another round of asset purchases.”

‘Positive Action’

The Fed will give “strong hints” or provide “positive action” next week, Bill Gross, who runs the world’s biggest bond fund at Pacific Investment Management Co. in Newport Beach, California, said in a radio interview on “Bloomberg Surveillance” with Tom Keene and Ken Prewitt. The central bank will likely ease further through “open ended” purchases of Treasuries and mortgages, he said.

Treasuries climbed on Aug. 31 as Bernanke, speaking at an economics conference in Jackson Hole, Wyoming, said the costs of “nontraditional policies” to spur the economy appeared manageable when considered carefully. He said the Fed stands ready to act if necessary.

“QE is a net negative for Treasuries, if it’s large enough to work,” said Tom Graff, who manages $3.6 billion of fixed income at Brown Advisory Inc. in Baltimore. “I don’t want to be a buyer of Treasuries with QE as an expectation,” though given the market reaction to today’s data, “that view appears to be a minority,” he said.

The Fed sold $7.8 billion of Treasuries today maturing from February 2013 to February 2014 as part of Operation Twist, its program to swap shorter-term securities in its holdings with longer-term debt to put downward pressure on borrowing costs.

Treasury Auctions

The Treasury will auction $66 billion in notes and bonds next week: $32 billion in three-year debt, $21 billion in 10- year securities and $13 billion in 30-year bonds.

Hedge-fund managers and other large speculators increased their net-long position in 10-year note futures in the week ending Sept. 4 to the highest level in more than four years, according to U.S. Commodity Futures Trading Commission data.

Speculative long positions, or bets prices will rise, outnumbered short positions by 108,685 contracts on the Chicago Board of Trade, the most since March 2008. Net-long positions rose by 57,993 contracts, or 114 percent, from a week earlier, the Washington-based commission said in its Commitments of Traders report.

To contact the reporters on this story: Daniel Kruger in New York at dkruger1@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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