Treasuries Gain on Slowdown; Two-Year Yield Near a Record Low

Treasuries advanced for a second day on concern the U.S. recovery is stalling, boosting demand for the relative safety of government notes.

Two-year note yields were close to a record low before reports this week forecast to show U.S. home sales fell and gross domestic product growth moderated, supporting the Federal Reserve Board’s willingness to keep interest rates low. The government will sell $37 billion in two-year notes today. U.S. bonds with maturities longer than 10 years have given investors an 19 percent return this year, compared with a 6.45 percent gain from shorter-dated debt, indexes from the European Federation of Financial Analysts Societies and Bloomberg show.

“I’m still sticking with government over credit,” said Stuart Short, a fixed-income strategist at Dinosaur Securities in London. “Deflation fears are definitely growing and this may be the reason behind the rally in the long-end of government bond markets.”

Ten-year yields fell five basis points to 2.55 percent at 7 a.m. in New York, according to BGCantor Market Data. The 2.625 percent security due August 2020 rose 15/32, or $4.69 per $1,000 face amount, to 100 20/32. The yield dropped to 2.53 percent on Aug. 20, the lowest level since March 2009.

The two-year note yield was one basis point lower at 0.48 percent after touching a record low 0.4547 percent on Aug. 20.

Concern that economies around the world are struggling to overcome the worst recession since World War II has helped send the 10-year yield almost 1.5 percentage points lower since the start of April and propelled U.K. and German yields to record low levels. Bank of England policy maker Martin Weale said the U.K. faces a “real risk” of a second recession, the London-based Times reported.

Home Purchases

Existing-home purchases slid 13 percent in July, according to a Bloomberg News survey before today’s data. A Commerce Department update on Aug. 27 will show the economy grew 1.4 percent in the second quarter, the slowest rate since the recovery began in the middle of last year, another survey showed.

Fed Chairman Ben S. Bernanke will discuss the outlook for the economy on Aug. 27 at a conference in Jackson Hole, Wyoming.

“There should be demand for the auctions as people want to hold Treasuries going into Bernanke’s Friday speech,” said Sean Murphy, a Treasury trader at Societe Generale SA in New York.

‘More Modest’

Following its Aug. 10 policy meeting, the central bank set a floor on its securities holdings and said growth would be “more modest in the near term than had been anticipated.”

Yesterday’s auction of 30-year Treasury Inflation Protected Securities, or TIPS, drew a yield of 1.768 percent, the lowest ever for sales of the debt dating to 1998. The bid-to-cover ratio, which gauges demand by comparing total bids with the amount of bonds offered, was a record high 2.78.

Indirect bidders, an investor class that includes foreign central banks, bought 38.9 percent of the bonds, compared with 42.4 percent in February. Direct bidders purchased 28 percent of the bonds, compared with 6.4 percent.

The 30-year U.S. breakeven rate has fallen to 1.93 percentage points from 2.10 percentage points a year ago. The rate, a gauge of market long-term inflation expectations, is derived from the yield spread between regular and index-linked bonds.

The two-year notes being sold today yielded 0.5 percent in pre-auction trading, versus the prior record low of 0.665 percent at the previous auction on July 27. Investors bid for 3.33 times the amount on offer last month, versus an average of 3.19 for the past 10 sales.

Fed Purchases

The Treasury is also scheduled to auction $36 billion of five-year debt tomorrow and $29 billion in seven-year securities the following day. Altogether, the $102 billion of notes being sold this week is the smallest total for this combination of securities since May 2009.

The Fed will purchase about $18 billion of U.S. debt by the middle of September using the money from principal payments on its holdings of agency debt and agency mortgage-backed securities. The central bank plans to buy notes due from 2013 to 2014 today and debt maturing from 2021 to 2040 on Aug. 26.

Treasuries also rose as stocks extended global losses and traders increased bets the Fed will cut interest rates. The MSCI World Index dropped 0.6 percent and the Standard & Poor’s 500 Index futures declined 0.7 percent.

Futures trading on the CME Group exchange showed a 33.3 percent chance the Fed will cut the target rate for overnight bank lending by its December meeting, up from a 26 percent probability one month ago.

The gap between yields on two- and 30-year Treasuries shrank to about 3.15 percentage points, the lowest since October 2009. The spread between two- and 10-year Treasury yields narrowed to 2.09 percentage points from 2.12 percentage points yesterday.

“The yield curve has more room for bull flattening,” said Hideo Shimomura, who helps oversee the equivalent of $53.3 billion in Tokyo as chief fund investor at Mitsubishi UFJ Asset Management Co., a unit of Japan’s biggest bank.

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