Treasuries Recoup Most QE3 Losses Amid Growth Skepticism

Treasuries rose, recovering most of the losses sustained after the Federal Reserve said it would add more stimulus, as traders wagered a slowing global economy will pose challenges to policy makers seeking to lower unemployment.

Benchmark 10-year note yields fell for the first week this month as reports showed manufacturing shrank in the New York area, Europe and China. Atlanta Fed President Dennis Lockhart said yesterday the central bank may take further action if the labor market doesn’t show signs of greater strength. The U.S. will auction $99 billion of notes next week.

“Although the economy is not double-dipping into another recession, the growth we’re seeing is not robust,” said Jason Rogan, director of U.S. government trading at Guggenheim Partners LLC, a New York-based brokerage for institutional investors. “There’s nothing coming out of the Fed saying that they will not come in and purchase more Treasuries.”

The 10-year yield dropped 11 basis points, or 0.11 percentage point, to 1.75 percent this week in New York, according to Bloomberg Bond Trader prices. The price of the 1.625 percent note due in August 2022 added 32/32, or $10 per $1,000 face amount, to 98 27/32.

The benchmark note yield closed at 1.76 percent on Sept. 12, the day before the Fed announced it would begin a third round of debt purchases under quantitative easing to spur jobs and growth. The yield climbed, reaching a four-month high of 1.89 percent on Sept. 14, before dropping this week.

Long Bonds

Thirty-year yields slid 15 basis points to 2.94 percent, their 200-day moving average. They were at 2.92 percent on Sept. 12, and rose to as high as 3.12 percent on Sept. 17. The yields briefly reached below the moving average on Sept. 20. The level is seen by some traders as a barrier to further decreases.

Volatility dropped to a four-month low. Bank of America Merrill Lynch’s MOVE index, which measures price swings based on options, touched 57.5 basis points on Sept. 19, the least since May 7, after reaching a 2012 high of 95.4 basis points on June 15. It was 59.6 basis points yesterday. The average over the past decade is 100.3 basis points.

Low volatility is “not going to go away,” said Thomas Roth, senior Treasury trader in New York at Mitsubishi UFJ Securities USA Inc. “It’ll change around auctions or big numbers, but in between the weeks when there’s no supply, it’s all about the Fed.”

Monthly Purchases

The central bank said Sept. 13 it will buy $40 billion of mortgage-backed bonds a month to pump money into the U.S. economy and boost employment. The U.S. jobless rate has been stuck at more than 8 percent for 43 straight months, prompting Fed Chairman Ben S. Bernanke to pledge to continue buying debt until the labor market improves “substantially.”

The Fed is also swapping shorter-term Treasuries in its holdings with those due in six to 30 years to lengthen the average maturity and hold down borrowing costs.

“MBS purchases will continue until we see a better employment situation,” Lockhart said yesterday in a speech in Atlanta. “If we do not see improvement, more action may be taken. And inflation will be monitored closely and kept near 2 percent.”

A gauge of traders’ outlook for consumer-price increases fell from a six-year high it reached after the Fed announcement. The gap in yield between 10-year notes and similar-maturity Treasury Inflation Protected Securities, known as the break-even rate, narrowed to 2.5 percentage points yesterday after touching 2.73 percentage points on Sept. 17, the most since May 2006. It has averaged 2.21 percentage points this year.

TIPS Auction

Treasuries pared gains Sept. 20 as an auction of 10-year TIPS drew the weakest demand in more than three years as investors speculated consumer prices may not rise as fast as initially expected.

The $13 billion issue’s bid-to-cover ratio, which gauges demand by comparing the amount bid with the amount offered, was 2.36, the lowest since April 2009. The sale drew a record low negative yield of 0.75 percent, versus the average forecast of negative 0.812 percent in a Bloomberg survey.

The Treasury will auction $35 billion of nominal two-year notes on Sept. 25, the same amount of five-year debt the next day and $29 billion of seven-year securities on Sept. 27.

Hedge-fund managers and other large speculators reversed bets on 30-year bond futures from a net-long position to a net- short position in in the week ended Sept. 18, according to U.S. Commodity Futures Trading Commission data.

Speculative short positions, or bets prices will fall, outnumbered long positions by 72 contracts on the Chicago Board of Trade. Last week, traders were net-long 20,088 contracts.

‘Slowing Down’

U.S. bonds rose this week as a gauge of manufacturing in the New York area, the New York Fed’s Empire State index, slid to a three-year low in September and purchasing-manager indexes showed both Chinese and euro-area manufacturing contracted.

“There’s growing sentiment that the major economies around the world are slowing down,” David Coard, head of fixed-income trading in New York at Williams Capital Group, a brokerage for institutional investors, said Sept. 20. “That’s helping to generate a bid for Treasuries.”

Yields fluctuated yesterday on speculation whether European leaders were making progress on the region’s debt crisis.

European governments “need to proceed toward a full accomplishment of economic and monetary union and create conditions for growth and the creation of jobs,” according to a statement from Italian Prime Minister Mario Monti’s office following a meeting with his Spanish counterpart, Mariano Rajoy, in Rome yesterday.

Spanish Reluctance

While Monti championed a European Central Bank plan to purchase the debt of distressed nations in the euro bloc, ECB President Mario Draghi’s insistence on imposing conditions on any aid has left Monti and Spanish Prime Minister Mariano Rajoy reluctant to seek a bailout, a requirement.

The gap between 10-year interest-rate swap rates and similar-maturity Treasury yields was 1.4 basis points yesterday, after narrowing Sept. 20 to minus 0.06 basis point, the first time since September 2010 that yields on the swaps fell below those on Treasuries. A negative reading indicates increased demand for investments outside the Treasury market.

Investors use swaps to exchange fixed and floating interest-rate obligations. The difference, the gap between the fixed component and the Treasury rate, is a gauge of investor demand for higher-yielding assets. The spread is usually positive because investors demand more yield to compensate for the risk of a swap, a transaction between banks, than they do to lend to the U.S. government.

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

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

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