Treasuries Gain on Durable-Goods Drop as Economy Shrinks

Treasuries rose, sending yields on benchmark 10-year notes to a three-week low, as reports showed the U.S. economy contracted more than forecast last quarter and demand for durable goods decreased.

Yields dropped for a second day as the U.S sold $35 billion in five-year notes at higher-than-average demand. The difference between yields on two- and 10-year notes narrowed to almost the least in a year, suggesting investors are questioning the pace of potential Federal Reserve interest-rate increases next year. Treasuries rose earlier as Middle East turmoil stoked refuge demand.

“The weaker data combination is supporting Treasuries,” said Larry Milstein, managing director in New York of government-debt trading at R.W. Pressprich & Co. “The decent auction and the backdrop of political risk adds to the move.”

Benchmark 10-year yields fell two basis points, or 0.02 percentage point, to 2.56 percent at 5 p.m. in New York after touching 2.53 percent, the lowest level since June 3, according to Bloomberg Bond Trader data. They dropped five basis points yesterday. The 2.5 percent note maturing in May 2024 climbed 5/32, or $1.56 per $1,000 face amount, to 99 15/32.

Current five-year note yields fell two basis points to 1.65 percent after reaching 1.61 percent, the lowest since June 6.

Yield Curve

The gap between yields on two-year notes and 10-year debt, known as the yield curve, narrowed to as little as 2.05 percentage points. It touched 2.04 percentage points on May 29, the least since June 2013.

Shorter maturities are more sensitive to what the Fed does with interest rates, while longer-dated debt is more influenced by the outlook for inflation. The flattening of the yield curve suggests investors are betting slower growth will limit the rise in long-term borrowing rates.

The five-year notes sold today drew a yield of 1.67 percent, compared with a forecast of 1.66 percent in a Bloomberg News survey of six of the Fed’s 22 primary dealers.

The bid-to-cover ratio, which gauges demand by comparing total bids with the amount of securities offered, was 2.74, versus an average of 2.68 for the past 10 sales.

Indirect bidders, an investor class that includes foreign central banks, purchased 52.5 percent of the notes, compared with an average of 44.8 percent for the past 10 sales.

Direct bidders, non-primary-dealer investors that place their bids directly with the Treasury, purchased 9.3 percent of the notes at the sale, compared with an average of 13.1 percent for the past 10 auctions.

‘Fair Auction’

Five-year notes have returned 1.5 percent this year, versus a gain of 2.8 percent by the broad Treasuries market, according to Bank of America Merrill Lynch indexes. The five-year securities lost 2.4 percent in 2013, while Treasuries overall fell 3.4 percent.

“It was a fair auction, decent demand -- global fixed-income continues to trade very very well despite the fact most market pundits were calling for higher rates this year in an improving economy,” said Guy Haselmann, an interest-rate strategist in New York at Bank of Nova Scotia, which as a primary dealer must bid at U.S. debt auctions. “Growth and inflation expectations have been overly rosy for four years in a row, and the risks are they will continue to be overly rosy.”

Floater Demand

The Treasury also sold $13 billion of two-year floating-rate notes today, drawing a bid-to-cover ratio of 4.43, compared with 4.69 at the May sale. It exceeded the coverage ratio at yesterday’s sale of two-year fixed-rate notes, which was 3.23. The high discount margin at the sale was 0.069 percent, matching the highest since the first offering of the notes in January.

Today’s offerings were the second and third of four auctions of coupon-bearing debt this week. The government sold $30 billion in two-year notes yesterday at a yield of 0.511 percent, the highest in over three years, and will offer $29 billion in seven-year notes tomorrow.

Treasuries have gained 3 percent this year, according to the Bloomberg U.S. Treasury Bond Index, after losing 3.4 percent in 2013.

Bank of America Merrill Lynch’s MOVE Index, which measures price swings based on options, was at 54 basis points today. It declined to 53.86 basis points yesterday, the lowest since May 9, 2013.

U.S. government debt rose as gross domestic product fell at a 2.9 percent annualized rate, more than forecast and the worst reading since the same three months in 2009, after a previously reported 1 percent drop, the Commerce Department said today in Washington.

‘Off Guard’

“Even though it’s an old number, people were still caught off guard, and that led to buying in the Treasury market,” said Ian Lyngen, a government-bond strategist at CRT Capital Group LLC in Stamford, Connecticut.

Demand for items meant to last at least three years decreased 1 percent in May, reflecting declines in the volatile transportation and defense categories, the Commerce Department said.

Treasuries gained earlier as Iraq’s Prime Minister Nouri al-Maliki rejected calls to relinquish power to allow the formation of a national “salvation” government to defeat Sunni militants threatening to break up the country. The violence today spread to Kirkuk, the northern region’s oil hub, where a car bomb killed at least seven people and wounded 20, according to a police statement.

Fed Expectations

There’s a 58 percent chance the Fed will raise its benchmark rate to at least 0.5 percent by July next year, based on Fed funds futures, compared with a 43 percent probability at the end of last month.

Fed policy makers cut monthly debt purchases by $10 billion to $35 billion at their June 17-18 meeting, while leaving the target rate for overnight lending between banks in the range of zero to 0.25 percent, where it has been since December 2008.

A report tomorrow is forecast to show the personal consumption expenditures price index (BUSY) rose to 1.8 percent last month from a year ago, the highest since October 2012, according to the median estimate of economists in a Bloomberg News survey. The Fed’s 2 percent annual inflation goal is based on the PCE price index.

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

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

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