Treasuries Decline Before Two-Year Note Sale as Volatility Drops

Treasuries fell for the first time in three days as the U.S. prepared to sell $35 billion of two-year notes amid speculation the Federal Reserve is moving closer to winding down its asset-purchase program.

Price swings in the Treasury market as measured by options declined, signaling the central bank can probably reduce its stimulus program without increasing volatility. The Fed will start trimming its $85 billion in monthly bond purchases in September, according to a survey of economists by Bloomberg News released today. The auction is part of $99 billion of notes the government is scheduled to sell this week.

“The market is settling back into the fact that tapering is going to occur,” said Thomas Roth, senior Treasury trader in New York at Mitsubishi UFJ Securities USA Inc. “The market is defining 2.50 percent on 10s as a level that kind of makes sense. The two-year auction should go well -- front-end paper is in demand.”

The U.S. 10-year yield rose two basis points, or 0.02 percentage point, to 2.50 percent at 12:13 p.m. in New York, according to Bloomberg Bond Trader prices. The 1.75 percent note due in May 2023 fell 5/32, or $1.56 per $1,000 face amount, to 93 1/2. The yield has dropped from 2.75 percent on July 8, the highest level since August 2011.

Treasuries handed investors a loss of 2.2 percent this year through yesterday, according to Bloomberg World Bond Indexes. The MSCI All-Country World Index of shares returned 12 percent including reinvested dividends.

Net Longs

Treasuries investors raised bets the price of the securities will gain in price, becoming the most bullish since November, according to a survey by JPMorgan Chase & Co.

The proportion of net longs, or bets the securities will rise, increased to 10 percentage points in the week ending yesterday, from 8 percentage points the previous week. The figure is the highest level of bullish bets since Nov. 12. The percentage of outright longs rose to 23 percent from 21 percent.

The percentage of outright shorts, or bets the securities will fall in value, was unchanged from the previous week at 13 percent. Investors cut neutral bets to 64 percent from 66 percent.

The two-year notes scheduled for sale today yielded 0.34 percent in pre-auction trading, compared with 0.43 percent at the previous sale of the securities on June 25.

Demand Falls

Demand weakened at the previous two two-year offerings. The bid-to-cover ratios, which gauge demand by comparing the amount bid with the amount offered, at the June and May auctions were 3.05 and 3.04, the two lowest since February 2011, according to Treasury data compiled by Bloomberg.]

The three auctions this week will raise a total of $30.6 billion of new cash with $59.4 billion in securities maturing.

“There’s money that needs a home and a lot of times it just gets recycled,” said Guy Haselmann, an interest-rate strategist at Bank of Nova Scotia in New York, one of 21 primary dealers that trade with the Fed. “That helps the auctions go just fine.”

The yield on current two-year notes rose one basis point to 0.31 percent. The rate will climb to 0.41 percent by year-end, according to analyst estimates compiled by Bloomberg.

An index measuring 10-day price volatility in Treasuries dropped to 2.44 percent yesterday from 7.49 percent on July 8, which was the highest since November 2011.

The Merrill Lynch Option Volatility Estimate Move Index fell to 72.62 yesterday, the lowest level in almost two months. The figure is down from 117.89 basis points on July 5, which was the most since December 2010. The one-year average is 64.7.

‘Much Calmer’

“The market has been much calmer,” said Annalisa Piazza, a fixed-income analyst at Newedge Group in London. “Investors have finally got the right message that, while the Fed may reduce the amount of bonds it purchases in coming months, its policy will remain accommodative.”

None of the 54 economists surveyed by Bloomberg from July 18-22 predicted the Federal Open Market Committee will begin reducing its monthly purchases at its meeting scheduled for July 30-31.

In its first reduction, the FOMC will probably cut monthly bond buying to $65 billion, according to the survey. Economists see purchases divided between $35 billion in Treasuries and $30 billion in mortgage-backed securities.

The central bank will purchase up to $3.75 billion in Treasuries today maturing between April 2019 and June 2020.

Bernanke’s View

The Fed has kept its target for overnight bank lending in a range of zero to 0.25 percent since December 2008. It has said it will consider raising the target when the unemployment rate falls to 6.5 percent, versus 7.6 percent as of June.

Fed Chairman Ben S. Bernanke told congressional panels last week it was “way too early to make any judgment” about whether the biggest buyer of Treasuries will start cutting back in September.

Benchmark yields jumped 17 basis points June 19 after Bernanke said the central bank may start dialing down its unprecedented bond-buying program this year and end it entirely in mid-2014 if the economy finally achieves sustainable growth.

Ten-year notes rose yesterday as an industry report showed purchases of existing homes fell 1.2 percent to a 5.08 million annual rate, boosting demand for safer assets. New home sales rose for a fourth month in June, based on a separate survey before the Commerce Department releases the data tomorrow.

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