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Treasury Volatility Drops on Yellen Low-Rates Message

The difference between five- and 30-year yields narrowed to the least since 2009 as Federal Reserve Chair Janet Yellen told lawmakers monetary stimulus is still required while increases in interest rates may occur sooner if the economy accelerates.

Longer-term Treasuries outperformed as Yellen pointed to “significant slack” in labor markets and reiterated interest rates are likely to stay low for a considerable period after bond purchases end. Industrial production growth slowed more than forecast in June and wholesale inflation remained below 2 percent, government reports showed.

“We have a flattening bias -- that’s a function of the market preparing for an eventual tightening in policy, even though it’s some ways off,” said Christopher Sullivan, who oversees $2.3 billion as chief investment officer at United Nations Federal Credit Union in New York. “She’s still very committed to remaining accommodative, until we make a complete recovery.”

The U.S. 30-year yield fell three basis points, or 0.03 percentage point, to 3.34 percent at 5 p.m. New York time, according to Bloomberg Bond Trader data. The price of the 3.375 percent note due in May 2044 rose 18/32, or $5.63 per $1,000 face value, to 100 22/32. Five-year note yields rose two basis points to 1.70 percent. The yield on the 10-year note dropped two basis points to 2.53 percent.

Yield Difference

The spread between five-year notes and 30-year bonds, known as the yield curve, shrank as low as 164 basis points, the least since February 2009. 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 amount of Treasuries traded through ICAP Plc, the largest inter-dealer broker of U.S. government debt, dropped to $220 billion, from $342 billion yesterday. The daily average volume this year is $330 billion.

Treasuries held by China, the largest foreign holder of the debt, rose for the first time in four months by $7.7 billion or 0.6 percent in May to $1.27 trillion, according to the U.S. Treasury Department. The country’s holdings are little changed for the year.

Japan, the second largest foreign holder of U.S. government securities, increased its position in the debt by $10.4 billion or 0.9 percent to $1.22 trillion, its most ever, the Treasury said.

Overseas Owners

Total foreign holdings of Treasuries increased $15.1 billion, or 0.3 percent, to a record $5.98 trillion. It was the 10th consecutive monthly jump, the longest streak since the 15-month period from January 2012 through March 2013.

Overseas investors have boosted their stake in U.S. government debt by 2.7 percent this year, or $174 billion, after rising 4.1 percent last year, the smallest gain since 2006.

Treasury market volatility fell to almost the lowest in a year. Volatility across asset classes has tumbled this year as central banks around the world pledged to keep interest rates lower for longer to support the economic recovery. Those same policies are also underpinning demand for fixed-income securities even as they stimulate growth.

Bank of America Merrill Lynch’s MOVE Index, which measures price swings in Treasuries based on options, fell for a third day yesterday, declining to 54.03 basis points. It dropped to 52.74 on June 30, the lowest since May 2013. The gauge has averaged 91.7 during the past decade.

Yellen Testimony

“If the labor market continues to improve more quickly than anticipated,” then increases in the federal funds rate target likely would occur sooner than currently envisioned, Yellen told the House Financial Services Committee.

The Fed also said economic growth was modest to moderate as all 12 of its districts reported stronger consumer spending and expanded manufacturing, and a third saw “robust to very strong” auto sales. The central bank outlook was contained in the Beige Book business survey, which is based on reports from its regional reserve banks.

“People have been living on pledges of the uber-doves to keep rates low,” said Thomas Roth, senior Treasury trader in New York at Mitsubishi UFJ Securities USA Inc. “She indicated things are better than expected. She still couched it by talking about risks.”

Richard Fisher, president of the Fed Bank of Dallas, said the central bank may raise its benchmark interest rate sooner than expected.

Fisher View

“We are at risk of doing what the Fed has too often done: overstaying our welcome by staying too loose too long,” the Dallas Fed’s Fisher said in remarks prepared for a speech in Los Angeles. The Fed may need to start raising its benchmark interest rate “early next year, or potentially sooner depending on the pace of economic improvement,” he said.

Traders see a 60 percent chance the Fed will raise its key rate by July 2015, compared with about 53 percent at the end of June, federal fund futures contracts show. The central bank has kept its target for the benchmark fed funds rate in a range of zero to 0.25 percent since December 2008.

Industrial production climbed 0.2 percent in June following a revised 0.5 percent advance in May, figures from the Fed showed. The median forecast in a Bloomberg survey of economists called for a 0.3 percent advance.

Companies paid 1.9 percent more for goods and services in June than a year earlier, according to a Labor Department report. That matched the median forecast of economists surveyed by Bloomberg and was down from a 2 percent year-over-year increase in May.

Benchmark 10-year note yields will rise to 3 percent by the end of the year, according to the median estimate in a Bloomberg News survey of economists.

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 Paul Cox

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