U.S. 2-Year Notes Rally After Yellen Damps Rate Bets

Treasury two-year notes gained the most in four weeks as Federal Reserve Chair Janet Yellen tempered speculation that an improving economy would accelerate an increase in interest rates.

The rally in the government securities most sensitive to changes in expectations in Fed policy increased the yield gap with 30-year (USGG30YR) bonds the most in six months after Yellen told Congress America’s economic recovery is uneven. She said it still needs support even as the Fed winds down quantitative easing stimulus. Ten-year (USGG10YR) notes fell for the first time in three weeks before data next week that may show inflation rose.

“There were expectations that once QE ended, you may have a rate hike in the first half of next year,” said Charles Comiskey, New York-based head of Treasury trading at Bank of Nova Scotia in New York, one of 22 primary dealers that trade with the U.S. central bank. “From what Yellen said, you’ve got to think otherwise.”

The two-year note yield fell four basis points, or 0.04 percentage point, to 0.38 percent this week in New York, according to Bloomberg Bond Trader prices. It was the biggest decline since the five days ended April 11. The price of the 0.375 percent security due in April 2016 gained 2/32, or 63 cents per $1,000 face amount, to 99 31/32.

The 30-year bond yield climbed 10 basis points to 3.46 percent after dropping to 3.35 percent on May 5, the lowest level since June 19. Ten-year note yields rose four basis points to 2.62 percent.

Yield Curve

The yield difference between two- and 30-year Treasuries, known as the yield curve, widened 14 basis points this week to 308 basis points. It was the first increase in five weeks and the biggest since Nov. 8.

Historically, a steeper yield curve reflects diminishing demand from investors anticipating faster economic growth and inflation. The yield curve steepens when yields on shorter-term notes fall, those on longer-dated bonds rise, or both happen simultaneously.

The Bloomberg U.S. Treasury Bond Index (BUSY) has gained 2.7 percent this year, after losing 3.4 percent last year. It rose 0.3 percent this month through May 8.

Short-term notes outperformed this week. Treasuries maturing in one-to-five years returned 0.1 percent this week through May 8, according to the Bloomberg U.S. Treasury Bond indexes. Securities due in 10 years and longer dropped 0.7 percent, the indexes show.

‘Still Unemployed’

Yellen said in two days of testimony to U.S. lawmakers the world’s biggest economy still requires a strong dose of stimulus five years after the recession ended because unemployment and inflation are short of the Fed’s goals. While data show “solid growth” in the second quarter, “many Americans who want a job are still unemployed,” she said.

The Fed is unwinding the QE bond-buying program it has used to hold down longer-term borrowing costs and spur growth. It has cut monthly purchases by $10 billion at each of the past four meetings, from $85 billion last year, and has said further reductions are likely in “measured steps” if economic progress continues.

Policy makers have kept their target for the overnight lending rate between banks in a range of zero to 0.25 percent since December 2008 to support the economy.

Yellen “moved the needle for when rates rise to the back half of 2015,” Adrian Miller, director of fixed-income strategies at GMP Securities LLC in New York, said yesterday. “She confirmed her dovish bias.”

Rate Bets

Futures prices put the likelihood the Fed will start increasing the benchmark interest rate by its June 2015 policy meeting at 47 percent yesterday, based on trading on the CME Group Inc.’s exchange. The probability of a boost by the October 2015 meeting was 90 percent.

The U.S. sold $69 billion of three-, 10- and 30-year debt this week, attracting the lowest demand for the monthly series of auctions of the maturities since October. The ratio of bids to debt sold was 2.83 times, compared with 2.99 times in April, according to data compiled by Bloomberg.

Bidding at the $16 billion long-bond auction was the weakest since August 2011, with a bid-to-cover ratio of 2.09, as the lowest yields on the securities in more than 10 months reduced demand.

Thirty-year bonds had rallied this year amid persistently low inflation and as turmoil between Russia and Ukraine fueled haven demand. The longest-maturity debt issued by the U.S. has returned 11 percent this year, the biggest winner among Treasuries, after losing 15 percent in 2013.

Inflation Measure

The Fed’s preferred measure of inflation, the personal consumption expenditures deflator, has fallen short of the bank’s 2 percent target for almost two years. The gauge rose 1.1 percent in March from a year ago, a report on May 1 showed.

Data due on May 15 is projected to show the consumer price index rose in April by 2 percent on an annualized basis, compared with 1.5 percent the previous month, according to a Bloomberg forecast of 35 economists.

Ten-year note yields will increase to 3.25 percent by year-end and 30-year bond yields will rise to 4.05 percent, according to median forecasts in Bloomberg surveys of analysts.

“The bias is higher for yields as time goes on,” Dan Greenhaus, chief global strategist in New York at BTIG LLC, said yesterday. “Growth should accelerate and inflation should stabilize.”

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

To contact the editors responsible for this story: Dave Liedtka at dliedtka@bloomberg.net Greg Storey, Kenneth Pringle

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