U.S. 10-Year Yield Reaches 3-Week High Amid Auction, Fed

Treasury 10-year note yields rose to a three-week high as the U.S. sold $21 billion of the debt while investors bet the Federal Reserve will add more stimulus at the conclusion of its two-day policy meeting tomorrow.

Thirty-year bonds slid for a second day as a gauge of inflation expectations in the U.S. reached the highest level since March. Demand for refuge waned after Germany’s top constitutional court backed the ratification of Europe’s permanent bailout fund. Treasuries extended losses as the U.S. debt auction, the second of three note and bond sales this week, drew lower-than-average demand.

“You’ve got Treasury supply at a time when optimism is in play,” 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 market is clearly anticipating more accommodation from the Fed.”

The yield on the benchmark 10-year note climbed six basis points, or 0.06 percentage point, to 1.76 percent at 5 p.m. in New York trading, according to Bloomberg Bond Trader prices. It touched 1.77 percent, the highest level since Aug. 22. The price of the 1.625 percent note due in August 2022 dropped 1/2, or $5 per $1,000 face amount, to 98 25/32.

The 30-year bond yield increased seven basis points to 2.92 percent after advancing five basis points yesterday.

Inflation Bets

The difference between yields on 10-year notes and similar- maturity Treasury Inflation Protected Securities, a gauge of traders’ outlook for consumer prices, touched 2.41 percentage points, the widest since March 21. The average over the past decade is 2.16 percentage points.

Bill Gross, who runs the world’s biggest bond fund, reduced his holdings of U.S. Treasuries to the lowest since October while warning that more stimulus from the Fed will lead to a resurgence of inflation.

Gross cut the proportion of U.S. government and Treasury debt in Pacific Investment Management Co.’s $272 billion Total Return Fund to 21 percent of assets in August, from 33 percent the previous month, according to a report on the Newport Beach, California-based company’s website today. Mortgage assets were trimmed to 50 percent, from 51 percent. Pimco doesn’t comment directly on monthly changes in portfolio holdings.

“QEs lower real interest rates and raise nominal rates because their intent is to reflate,” Gross wrote in a Twitter post earlier today, referring to the Fed’s two rounds of bond purchases since 2008 under the stimulus strategy called quantitative easing.

Weaker Demand

At today’s auction, the bid-to-cover ratio, which gauges demand by comparing total bids with the amount of securities offered, was 2.85, versus an average of 3.09 at the past 10 sales. The offering drew a yield of 1.764 percent, matching the average forecast in a Bloomberg News survey of eight of the Fed’s 21 primary dealers.

Indirect bidders, an investor class that includes foreign central banks, purchased 36.2 percent of the notes, compared with an average of 42 percent for the past 10 sales. Direct bidders, non-primary-dealer investors that place their bids directly with the Treasury, bought 11.6 percent, versus an average of 17 percent at the past 10 offerings.

“It was weaker than anticipated, which caused Treasuries to trade off a bit,” said Milstein of Pressprich.

Tomorrow’s Auction

The government will auction $13 billion of 30-year debt tomorrow. It sold $32 billion in three-year notes yesterday, drawing a yield of 0.337 percent and a bid-to-cover ratio of 3.94, the highest on record.

“Dealers kind of welcomed the back-up this week in terms of setting up a concession for what will be a tougher auction still,” said Christopher Sullivan, who oversees $2 billion as chief investment officer at United Nations Federal Credit Union in New York, referring to tomorrow’s sale.

Treasuries were the least expensive in three weeks, according to the 10-year term premium, a model created by economists at the Fed that includes expectations for interest rates, growth and inflation. It was at negative 0.84 percent, the least costly level since Aug. 21. A negative reading shows investors are willing to accept yields below what’s considered fair value. This year’s average is negative 0.73 percent.

Fed Policy

The Fed is scheduled to issue a policy statement tomorrow at about 12:30 p.m. in Washington. Almost two-thirds of economists in a Bloomberg survey projected it will announce a third round of debt purchases, while also extending into 2015 its pledge to keep interest rates low.

Policy makers will probably start an open-ended plan tied to a sustained improvement in the economy rather than specify an amount of purchases and an end-date, according to 32 of the 73 economists in the survey. Twenty-two respondents expect a fixed duration and amount.

Two rounds of Fed bond purchases totaling $2.3 trillion have failed to breathe life into the labor market, which Chairman Ben S. Bernanke said last month is a “grave concern.” Unemployment has been stuck above 8 percent for 43 straight months, while the U.S. economy grew less than 2 percent in the second quarter.

The central bank is also in the process of swapping shorter-term Treasuries in its holdings with those due in six to 30 years to put downward pressure on long-term borrowing costs. It sold $7.8 billion of securities today maturing from April 2014 to November 2014 as part of the program.

German 10-year bund yields touched 1.65 percent today, the highest level since June 29, as demand for refuge ebbed.

The German Federal Constitutional Court stipulated that a cap of about 190 billion euros ($246 billion) be placed on the country’s liabilities before the region’s permanent bailout fund, the European Stability Mechanism, is ratified, unless parliament decides to back extra funds.

The court dismissed motions filed by groups seeking to block the fund, ending legal challenges that delayed efforts by euro-area leaders to contain the debt crisis.

To contact the reporters on this story: Susanne Walker in New York at swalker33@bloomberg.net; Daniel Kruger in New York at dkruger1@bloomberg.net

To contact the editor responsible for this story: Dave Liedtka at dliedtka@bloomberg.net

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