Treasury Yield Curve Flattens as Traders Unwind Wrong-Way Bets

The yield gap between Treasury five-and 30-year securities narrowed for a third day as traders unwound wrong-way bets that the Federal Reserve would wait to announce a reduction of debt purchases until after the new year.

Five-year note yields rose to a three-month high after the central bank said this week it will start reducing monthly asset buying next month while holding its key rate at virtually zero. Thirty-year (USGG30YR) bonds gained for the first time in three days amid wagers inflation will stay in check as the Fed slows purchases. The U.S. economy grew faster in the third quarter than first reported, data showed.

“We’re having quite a rally” as investors reverse bets on higher long-term yields, said Ira Jersey, an interest-rate strategist at Credit Suisse Group AG in New York, one of 21 primary dealers that trade directly with the Fed. “People were caught in steepeners and didn’t want to have that risk on over the holiday.”

The five-year note yield jumped as much as eight basis points, or 0.08 percentage point, to 1.71 percent, the highest level since Sept. 13, before trading at 1.68 percent at 5 p.m. New York time, according to Bloomberg Bond Trader prices. It climbed 15 basis points this week. The price of the 1.5 percent security due in December 2018 fell 6/32, or $1.88 per $1,000 face amount, to 99 5/32.

Thirty-year bond yields dropped nine basis points to 3.82 percent. The benchmark 10-year yield declined four basis points to 2.89 percent.

‘Getting Crushed’

The difference between five- and 30-year yields, called the yield curve, shrank to as little as 214 basis points, the narrowest level since Sept. 16. The gap expanded to 256 basis points on Nov. 21, the widest since 2011. It narrowed 20 basis points in the past five days, the most in a week since May 2012.

“The flattening of the yield curve is continuing,” said Barra Sheridan, a rates trader at Bank of Montreal in London. “Five- and seven-year notes are getting crushed versus the long bond. Too many guys had steepeners on and didn’t believe the Fed was going to taper,” he said, referring to a bet that longer-maturity yields would rise compared with shorter-term ones.

Hedge-fund managers and other large speculators decreased their net-long position in two-year note futures in the week ended Dec. 17, snapping an eight-week string of increases, according to U.S. Commodity Futures Trading Commission data.

Net Longs

Speculative long positions, or bets prices will rise, outnumbered short positions by 32,141 contracts on the Chicago Board of Trade. They had reached 71,333 net-long positions the previous week, the Washington-based commission said in its Commitments of Traders report.

The net-long position in 30-year bond futures rose to 9,164 contracts on the Chicago Board of Trade, from 549 the previous week, the data showed.

The Federal Open Market Committee said after its Dec. 17-18 policy meeting it would cut its $85 billion in monthly purchases of Treasuries and mortgage-backed bonds by $10 billion starting in January. Fed Chairman Ben S. Bernanke said at a press conference the central bank may take “further measured steps” to slow the buying, depending on the performance of the economy.

The central bank bought $3.18 billion today of Treasuries due from August 2022 through August 2023 as part of the program.

The Fed will cut purchases in $10 billion increments over the next seven meetings before ending the program in December 2014, analysts forecast. The figure was the median projection in a Bloomberg survey of 41 economists taken yesterday.

‘Well Past’

Policy makers said in their statement this week it “likely will be appropriate to maintain the current target range for the federal funds rate well past” their 6.5 percent unemployment-rate threshold, especially if inflation stays below the Fed’s 2 percent target. The benchmark rate has been a range of zero to 0.25 percent since 2008.

Inflation as measured by the personal consumption expenditures price index rose 0.7 percent for the 12 months ended in October, and the jobless rate last month was 7 percent.

Thirty-year bond yields touched 3.81 percent, the lowest level since Nov. 29. It touched 3.96 percent, the highest since August 2011, on Dec. 6.

“Some people think inflation will fall as the Fed pulls back,” which has added to demand for long bonds, said Guy Haselmann, an interest-rate strategist at the primary dealer Bank of Nova Scotia in New York. “The marketplace now can expect about $10 billion of tapering at every meeting.”

Insufficient Confidence

Fed Bank of Boston President Eric Rosengren, the lone dissenter from the Fed’s decision this week, said he isn’t convinced the economy will improve next year.

“My assessment has brightened in recent months,” Rosengren said today in a statement posted on the Boston Fed’s website. “But, by the same token, I do not yet have sufficient confidence in this outlook to risk the removal of any monetary accommodation at this time.”

The Fed’s balance sheet will expand to about $4.4 trillion by the time the current stimulus program ends, according to median estimates in the Bloomberg survey on tapering. It increased to a record $4 trillion in the past week, as the central bank pushed on with its unprecedented asset purchases, according to a statement yesterday from the Fed.

U.S. gross domestic product grew at a 4.1 percent annualized rate in the third quarter, the strongest since the final three months of 2011 and up from a previous estimate of 3.6 percent, Commerce Department figures showed today in Washington. Economists surveyed by Bloomberg projected a 3.6 percent pace after 2.5 percent in the second quarter.

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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