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Treasuries Fall as Morgan Stanley Recommends Underweight

Treasuries fell a second day before data this week that economists said will show improvement in the U.S. labor market and consumer confidence as Morgan Stanley recommended going “maximum underweight” U.S. debt.

The extra yield that benchmark 10-year notes offer over their G-7 counterparts rose to 70 basis points, the most since April 2010, after European Central Bank policy makers last week unveiled an unprecedented stimulus package. Spain’s 10-year yield dropped below the U.S. for the first time since 2010. The U.S. is scheduled to sell $62 billion in notes and bonds over three days starting tomorrow.

“The overwhelming vote for the Treasury market is a bearish one,” said Thomas Tucci, managing director and head of Treasury trading in New York at CIBC World Markets Corp. “ECB policy is still developing. Global growth forecasts are still relatively subdued.”

The U.S. 10-year yield climbed two basis points, or 0.02 percentage point, to 2.6 percent at 5 p.m. New York time, according to Bloomberg Bond Trader prices. The 2.5 percent note due in May 2024 fell 1/8, or $1.25 per $1,000 face amount, to 99 3/32.

Yields on the benchmark notes rose 11 basis points last week, the most since the week ended March 7, and touched 2.64 percent, the highest since May 13.

Sell Recommendation

Investors should sell Treasuries on the relative U.S. economic strength, Matthew Hornbach, the global head of interest-rate strategy at primary dealer Morgan Stanley, wrote today in a note to clients.

“ECB policy should no longer place downward pressure on U.S. yields,” Hornbach wrote.

The economy “like an uncoiling spring” will spark growth and drive up inflation expectations, forcing the Fed to raise borrowing costs sooner than the market anticipates, according to Hornbach.

Morgan Stanley forecasts two-year note yields to rise to 1.1 percent by the middle of next year, from 0.4 percent, and 10-year note yields to climb to 3.1 percent under what it calls its base-case scenario.

The U.S. is scheduled to sell $28 billion of three-year notes tomorrow, $21 billion of 10-year securities the following day and $13 billion in 30-year bonds on June 12.

Treasury Auctions

The amount being sold is lower for all three securities than last month’s auctions of $29 billion of three-year notes, $24 billion of 10-year securities and $16 billion in bonds. Demand at those auctions fell to the weakest level in seven months.

Treasury 10-year notes have become the most coveted in almost a year in the short-term market for borrowing and lending securities amid a dearth of the debt before this week’s $21 billion auction.

Traders have been willing to pay to borrow the notes in exchange for loaning cash overnight for the most actively traded 10-year maturity, with a repurchase agreement rate at negative 2.94 percent, according to data from ICAP Plc tracked by Bloomberg. Many times traders short, or sell securities they’ve borrowed in the repo market, ahead a Treasury sale to profit if prices of the securities fall after the auction.

‘Very Special’

“It is typical for debt like this to get very special before an auction,” said Kenneth Silliman, head of U.S. short-term rates trading at Toronto-Dominion Bank’s TD Securities unit in New York. “There certainly seems to be a deep short base in the issue.”

Treasuries fell before U.S. reports this week that may show retail sales rose in May, initial claims for jobless insurance fell in the latest weekly report and consumer confidence improved in June, based on Bloomberg News surveys of economists.

U.S. employers added 217,000 workers in May, after hiring 282,000 in April, the Labor Department reported June 6. The U.S. jobs report marked the fourth month that employment increased by more than 200,000. The jobless rate held at 6.3 percent, the lowest level in almost six years.

“The ECB is in worst shape than the U.S., and the move in their relative yields is a reflection of the divergence,” said Aaron Kohli, an interest-rate strategist BNP Paribas in New York, one of 22 primary dealers that trade with the Fed. “The U.S. recovery may not be as strong or fast as people want, but Europe has been even worse at a time when the U.S is getting stronger.”

Fed Taper

The Fed is tapering its monthly asset purchases as officials debate how to end their ultra-loose monetary policy. It has kept the target for overnight lending between banks in a range of zero to 25 basis points since 2008. Policy makers next meet on June 17-18 after signaling at their April 29-30 meeting that interest rates would remain low for a “considerable time.”

The chance of a rate increase to 0.5 percent or more by December 2015 is 72 percent, according to data compiled by Bloomberg based on federal fund futures.

Spain’s 10-year note yield touched 2.57 percent, the least on record, after rising as high as 7.75 percent in July 2012.

The ECB ignited a rush for euro-are bonds last week when it became the first major central bank to charge rather than pay lenders for parking cash in its coffers. Policy makers cut the deposit rate to minus 0.1 percent, and reduced the benchmark interest rate to a record 0.15 percent as they battle a deteriorating economic outlook.

The euro-area economy is forecast to grow at a 1.1 percent rate in this year, then at 1.5 percent in 2015, according to the median forecasts of more than 50 economists and strategists in Bloomberg surveys. The U.S. economy is estimated to expand 2.5 percent this year and 3.1 percent next.

The Bloomberg Global Developed Sovereign Bond Index (BGSV) has returned 4 percent this year through June 6, compared with a loss of 4.6 percent in 2013.

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

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

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