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Treasuries Drop as U.S. Manufacturing Expands at Quicker Pace

Treasuries declined for the first time in three days as a gauge of U.S. manufacturing unexpectedly increased in August, reducing demand for the relative safety of government debt securities.

The 2-year note yield rose from within 2 basis points of the all-time low on evidence the world’s largest economy is recovering. U.S. yields gained earlier as reports showed China’s manufacturing growth accelerated and Australia’s economy expanded at the fastest pace in three years.

“We’re priced for a lot of bad things at these levels,” said Thomas Roth, senior Treasury trader at Bank of Tokyo-Mitsubishi UFJ Ltd. in New York. “When we get data that says maybe we overdid it, the market comes off.”

The 10-year note yield increased 11 basis points, or 0.11 percentage point, to 2.58 percent at 4:12 p.m. in New York, according to BGCantor Market Data. The price of the 2.625 percent security maturing in August 2020 dropped 29/32, or $9.06 per $1,000 face amount, to 100 14/32.

The 2-year note yield gained 3 basis points to 0.51 percent after touching the intraday low of 0.47 percent. The yield fell to the record low of 0.4542 percent on Aug. 24. A 2-point drop in the 30-year bond pushed the yield up 13 basis points to 3.64 percent. The 10-year note yield slid on Aug. 25 to 2.4158 percent, a 19-month low.

Yield Curve

The extra yield investors demand to hold 10-year notes over 2-year debt increased to 2.07 percentage points on eased concern the economic recovery is stalling. The spread narrowed on Aug. 26 to 1.96 percentage points, indicating the flattest yield curve on a closing basis since April 2009.

Volatility in the Treasury market reached a three-month high this week. Bank of America Merrill Lynch’s MOVE index, measuring price swings based on over-the-counter options maturing in 2 to 30 years, climbed to 109.7 on Aug. 30, the highest level since June 1.

The Institute for Supply Management’s manufacturing index rose in August to 56.3 from 55.5 in the previous month, the Tempe, Arizona-based group reported today. The median forecast of 78 economists in a Bloomberg News survey was for a drop to 52.8. Readings greater than 50 signal growth.

“It is a nice surprise about the economy,” said Gary Pollack, who helps oversee $12 billion as head of fixed-income trading at Deutsche Bank AG’s private wealth management unit in New York. “The bond market is overbought.”

August Rally

Treasury 10-year notes rallied last month the most since the end of 2008 as minutes of the Federal Reserve’s Aug. 10 meeting released yesterday indicated “increased downside risks” to the outlook for economic growth and inflation.

U.S. employers eliminated 100,000 positions in August after trimming 131,000 jobs in the prior month, according to the median forecast of 75 economists before the Labor Department’s payrolls report on Sept. 3.

“Puzzled at the strength in the ISM index, many investors are likely to await Friday’s jobs report before they begin to believe in the durability of the economic recovery again,” Anthony Crescenzi, market strategist and portfolio manager at Newport Beach, California-based Pacific Investment Management Co., wrote in a research note to clients. The firm operates the world’s biggest bond fund.

U.S. companies reduced employment by 10,000 jobs last month after adding a revised 37,000 positions in July, ADP Employer Services said today. The median forecast of 35 economists in a Bloomberg News survey was for an increase of 15,000 jobs.

The yield on 10-year Treasury note briefly pared its advance after the report on private employment before rebounding within 10 minutes of the data’s release.

‘Beginning to Fade’

“My enthusiasm for Treasuries as a short-term trade is beginning to fade,” Kevin Giddis, head of fixed-income sales, trading and research at the brokerage firm Morgan Keegan Inc. in Memphis, Tennessee, wrote in a note to clients. “It usually isn’t a bullish sign when a security trades lower despite the presence of ‘good’ news. A few short weeks ago, you could have counted on data like today’s ADP report to drive prices higher, not lower.”

Yields on 10-year notes will drop to an all-time low of 2 percent in the first quarter of 2011 as the Fed expands its purchases of U.S. debt, according to Bank of America Corp.

The central bank will buy $500 billion to $750 billion of Treasuries over six months and possibly more as needed to support the economy in a second round of quantitative easing, according to Priya Misra, head of U.S. rates strategy at Bank of America Merrill Lynch.

Fed Balance Sheet

“Our economists are looking for the Fed to embark on an expansion in its balance sheet,” Misra wrote in a research note to clients today. “This should lower the 10-year Treasury rate to below its historic lows.”

Treasuries also declined before the government announces tomorrow the sizes of three debt sales next week. The administration of President Barack Obama has increased U.S. publicly traded debt to a record $8.18 trillion as it borrows to sustain the economic expansion.

The U.S. will sell $33 billion of three-year notes on Sept. 7, $21 billion of 10-year debt the following day and $13 billion of 30-year bonds on Sept. 9, according to the average forecast in a Bloomberg News survey of 9 of the 18 primary dealers obligated to participate in U.S. auctions.

Treasuries fell earlier as China’s Purchasing Managers’ Index rose to 51.7 last month from 51.2 in July. Gross domestic product for Australia advanced 1.2 percent in the second quarter, the most since 2007, after a gain of a revised 0.7 percent in the previous three-month period.

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