Treasuries Rally as Jobs Report Cools Fed Tapering Speculation

Treasuries gained, pushing 10-year note yields down the most since May 2012, after employment growth in July trailed forecasts, damping speculation the Federal Reserve will slow the pace of bond purchases next month.

U.S. debt erased losses as the jobs report suggested the economic recovery isn’t resilient enough to reduce stimulus, according to Pacific Investment Management Co.’s Mohamed El-Erian. Benchmark yields have retreated after almost matching the two-year high reached a month ago, when the June employment report showed stronger-than-forecast gains. Fed policy makers reiterated in a statement this week that they could moderate the $85 billion in purchases each month if growth meets forecasts.

“The Fed would like to reduce the pace of stimulus, but they need an economic reason to do so,” said Ira Jersey, an interest-rate strategist at Credit Suisse Group AG in New York, one of 21 primary dealers that trade with the Fed. “They could make a move in September, but it could be smaller than initially thought.”

The benchmark U.S. 10-year yield fell 11 basis points, or 0.11 percentage point, to 2.60 percent at 5 p.m. New York time, Bloomberg Bond Trader data showed. The price of the 1.75 percent note due in May 2023 gained 29/32, or $9.06 per $1,000 face amount, to 92 23/32. The yield rose as much as four basis points earlier, touching the highest level since July 8.

The 11 basis point drop in 10-year yields was the biggest on a closing basis since May 30, 2012 as credit conditions in Europe worsened, fueling demand for safe assets.

Thirty-year bond yields dropped seven basis points to 3.68 percent, after touching 3.78 percent, the highest since August 2011.

Market Reset

“We are reversing the increase in yields we had over the last couple of days on an optimistic assessment of where the labor market was likely to go,” said Christopher Sullivan, who oversees $2.1 billion as chief investment officer at United Nations Federal Credit Union in New York. “We remain in the most recent range -- between 2.50 and 2.75 percent -- for the foreseeable future until the trend in the economic data suggests otherwise.”

The Fed’s purchases are intended to put downward pressure on interest rates, and policy makers are discussing whether the economy has improved enough for them to start reducing the purchases.

“Economic activity expanded at a modest pace during the first half of the year,” the Fed said following a two-day meeting of the Federal Open Market Committee July 31. “The Committee recognizes that inflation persistently below its 2 percent objective could pose risks to economic performance, but it anticipates that inflation will move back toward its objective over the medium term.”

Jobs Data

U.S. debt erased losses after the Labor Department reported 162,000 added jobs in July, compared with the median forecast of 185,000 in a Bloomberg News survey, while the unemployment rate fell to 7.4 percent. Treasuries rallied after the Fed’s July 31 statement.

The economy has added an average of 192,000 jobs this year through July, the fastest pace since 2005 when it created 207,000 positions per month, Labor Department data show. Average hourly earnings declined by 0.1 percent in July after a 0.4 percent gain in June, which was the highest since November. The median forecast in a Bloomberg News survey was for a 0.2 percent gain.

“If they’re going to taper, they have to taper not just because the economy is improving, but because they’re worried about the collateral damage,” Pimco’s El Erian, chief executive and co-chief investment officer at the world’s biggest manager of bond mutual funds, said on Bloomberg Television’s “In the Loop” with Betty Liu.

Futures Data

Fed funds futures show a 43.7 percent probability that the central bank will raise borrowing costs in January 2015 for the first time after the 2008 financial crisis, down from 49.8 percent yesterday.

The personal consumption expenditure deflator, the Fed’s preferred gauge of inflation, rose to 1.3 percent in June from a year earlier, rising from a 1 percent rise in May and a 0.7 percent increase in April that was the smallest since 2009, the Commerce Department reported today in Washington.

The PCE deflator rose 0.4 percent on a monthly basis, the most since February. The measure had declined in March and April, the first consecutive decrease since 2008.

“As long as the inflation numbers do turn up that does give the Fed the bandwidth to exit QE,” said Gemma Wright-Casparius, who manages the $32.1 billion Vanguard Inflation-Protected Securities Fund at Valley Forge, Pennsylvania-based Vanguard Group Inc.

The government will sell $72 billion of notes and bonds next week, raising $2.4 billion of new cash as investors will redeem $69.6 billion of securities maturing on Aug. 15.

Note Sale

The Treasury Department said July 31 it plans to sell the first floating-rate notes in January and expects to gradually decrease coupon-auction sizes during the coming quarter as the nation’s fiscal health improves.

A measure of demand at the U.S. Treasury Department’s debt auctions has fallen this year to the lowest level since 2009 as a drop in bond prices generates the biggest losses on government securities in four years.

Investors bid $2.91 for each $1 of the $1.257 billion of notes and bonds sold by the Treasury this year, compared with a record high $3.15 of bids last year. It’s the first decline in demand at the auctions since 2008, when the U.S. government increased note and bond offerings 59 percent to $922 billion as the recession and the financial crisis deepened.

Ten-year notes yielded 37 basis points more than bonds in an index of their G-7 peers yesterday, the biggest difference since May 2010, according to data compiled by Bloomberg.

U.S. government securities fell for a third month in July, declining 3.5 percent since April based on the Bloomberg U.S. Treasury Bond Index. (BUSY) Investment-grade company debt declined 4.1 percent over the past three months even after gaining in July, the Bloomberg USD Corporate Bond Index (BUSC) shows.

Hedge-fund managers and other large speculators reversed to a net-long position from a net-short position in 10-year note futures in the week ending July 30, according to U.S. Commodity Futures Trading Commission data. Speculative long positions, or bets prices will rise, outnumbered short positions by 11,903 contracts on the Chicago Board of Trade. Last week, traders were net-short 32,312 contracts.

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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