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Treasury Inflation Bets Climb to Five-Month High on Fed Outlook

Treasury-market inflation bets rose to a five-month high as traders wagered that bond purchases by the Federal Reserve will spur consumer-price growth.

The gap between yields on U.S. 10-year notes and equivalent inflation-linked securities, a gauge of price expectations called the breakeven rate, widened as investors bet the Fed will be successful in sparking inflation. Mohamed A. El-Erian, chief executive officer of Pacific Investment Management Co., led analysts and investors who say so-called quantitative easing will push up inflation. Treasuries fell even as data showed home prices in 20 U.S. cities rose at a slower pace than forecast.

“Breakevens are a good way to play the QE trade,” said Sean Maloney, a fixed-income strategist at Nomura International Plc in London. “We don’t think this pattern is about to end, but it may become more volatile.”

The yield on benchmark 10-year securities rose four basis points to 2.6 percent as of 9:11 a.m. in New York, according to BGCantor Market Data. It touched 2.6139 percent, the highest level since Sept. 24. The 2.625 percent security due in August 2020 fell 10/32, or $3.13 per $1,000 face amount, to 100 6/32. Two-year notes yielded 0.37 percent, versus the record low of 0.327 percent set on Oct. 12.

The difference between rates on 10-year notes and Treasury Inflation Protected Securities, a gauge of trader expectations for consumer prices, touched 2.19 percentage points, the most since May 18. A $10 billion sale of five-year Treasury Inflation Protected Securities, or TIPS, drew a yield of minus 0.55 percent yesterday, the first negative yield at a U.S. debt sale.

Dollar Versus Yen

The dollar rose 0.7 percent against the yen after trading near a 15-year low on the outlook for Fed easing. The U.S. currency bought 81.35 yen, from as little as 80.41 yen yesterday, the weakest level since April 1995.

Treasuries still offer value, said Yusuke Tanaka, senior dealer for Mitsubishi UFJ Trust & Banking Corp. in Singapore, part of Japan’s largest publicly traded lender.

“The economy’s not improving,” Tanaka said. “The rally’s not over.” He plans to buy 10-year notes at a yield of 2.7 percent, he said.

Ten-year yields will be little changed at 2.57 percent by Dec. 31, according to a Bloomberg survey of banks and securities companies, with the most recent forecasts given the heaviest weightings.

U.S. unemployment has been more than 9 percent since May 2009.

The S&P/Case-Shiller index of property values increased 1.7 percent in August from 12 months earlier, the smallest year-over-year gain since February, the group said today in New York. The median forecast of 27 economists surveyed by Bloomberg News projected a 2.1 percent increase. Consumer confidence rose in October, economists in another survey said before data today.

Auction Demand

The U.S. is scheduled to auction $35 billion of two-year notes today, to be followed by sales of five-year debt tomorrow and seven-year securities on Oct. 28.

The two-year notes yielded 0.39 percent in pre-auction trading, versus the prior record low of 0.441 percent at the previous auction on Sept. 27. Investors bid for 3.78 times the amount on offer last month, versus an average of 3.2 for the past 10 sales.

Indirect bidders, the category of investors that includes foreign central banks, bought 39 percent of the notes, compared with the 10-sale average of 37.6 percent.

Rising costs for metals, food and oil show the central bank is preventing deflation, John Brynjolfsson, chief investment officer at Aliso Viejo, California-based Armored Wolf LLC, said in an interview yesterday on Bloomberg Television. Deflation is a general drop in prices.

Inflation ‘Bazooka’

“Their second goal is to achieve their target of 2 percent inflation,” he said. “The bazooka they have of quantitative easing should convince market participants that if that’s what they want, that’s what they’re going to get.”

Fed Treasury purchases will spur global inflation while failing to bring down U.S. unemployment, El-Erian said yesterday. Pimco, based in Newport Beach, California, manages the world’s biggest bond fund.

The central bank announced Aug. 10 that it will reinvest principal payments from its holdings of mortgage debt in U.S. government securities. It plans to buy Treasuries maturing from February 2021 to August 2040 today as part of that plan, according to its website.

The Fed will probably add to its purchases at its next meeting Nov. 2-3, El-Erian said. The central bank “is terrified of deflation,” he said.

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