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Treasuries Fall as Fed Coordinates to Cut Europe Funding Cost

Treasuries dropped, pushing 10-year yields to the highest in two weeks, after the Federal Reserve and five other central banks cut the cost of emergency dollar funding for European banks in response to the continent’s sovereign-debt crisis.

The two-year U.S. interest-rate swap spread narrowed to the lowest in almost three weeks as bank funding concern lessened. U.S. debt extended losses after a private report showed the U.S. added more jobs than forecast in November before the Labor Department releases employment data on Dec. 2. The Fed said it was joined in the swap rate cut by the Bank of Canada, Bank of England, Bank of Japan, European Central Bank and the Swiss National Bank.

“It’s going to free up some of the locked-up lending that’s going on in Europe,” said Brian Edmonds, head of interest rates at Cantor Fitzgerald LP in New York, one of 21 primary dealers that trade with the Fed. “It’s hard to look at this move and not think what they did was significant, but I don’t think it ends everything.”

The benchmark 10-year yield rose eight basis points, or 0.08 percentage point to 2.07 percent at 5 p.m. New York time, according to Bloomberg Bond Trader prices. The 2 percent security due in November 2021 fell 22/32, or $6.88 per $1,000 face amount, to 99 12/32. The yield rose as high as 2.11 percent, the most since Nov. 14.

Treasury Returns

Demand for the perceived safety of U.S. government securities resulted in a 1.1 percent gain this month as of yesterday, based on Bank of America Merrill Lynch data. German debt lost 0.9 percent, and Japanese bonds were little changed, the indexes show. Treasuries have returned 9.1 percent this year, the most since 2008.

The difference between yields on Treasuries maturing in two- and 10-years widened seven basis points to 1.81 percentage points, touching the most since Nov. 14.

The two-year swap spread, the difference between two-year swap rates and comparable maturity Treasury yields, an indication of perceived funding risk in the financial system, narrowed by almost 11 basis points to 41.55 basis points, the lowest since Nov. 10.

The dollar funding rate interest rate has been reduced to the dollar overnight index swap rate plus 50 basis points, or half a percentage point, from 100 basis points, and the program was extended to Feb. 1, 2013, the Fed said in a statement in Washington.

Less Strain

“The purpose of these actions is to ease strains in financial markets and thereby mitigate the effects of such strains on the supply of credit to households and businesses and so help foster economic activity,” the statement said.

The central banks acted after the cost for European banks to fund in dollars rose to the highest levels in three years as concern about a possible breakup of the euro area increased after leaders said they’d failed to boost the region’s bailout fund as much as planned.

“It is a vote of confidence to the market that the ECB is in,” said Ian Lyngen, a government bond strategist at CRT Capital Group LLC in Stamford, Connecticut. “It is consistent with an ECB that has shifted its general direction of policy from on-hold, slash, tighter to an easing stance.”

Under the dollar liquidity-swap program, the Fed lends dollars to the ECB and other central banks in exchange for currencies including euros. The central banks lend dollars to commercial banks in their jurisdictions through an auction process.

Market Function

“They are seeing something in the functioning in the banking system that worries them and they are hopefully taking preemptive measures to relieve that pressure,” said Mohamed El-Erian, chief executive and co-chief investment officer at Pimco, the world’s biggest manager of bond funds, said in a radio interview on “Bloomberg Surveillance” with Tom Keene and Ken Prewitt. “The short term impact is unambiguously positive for risk markets.”

The Fed said its sale of between $8 billion and $8.75 billion of debt maturing in 2013 originally scheduled for today will be conducted Dec. 2, according to a statement on the Fed Bank of New York’s website. The Fed is replacing $400 billion of short-term debt in its portfolio with longer-term securities through June in program known as Operation Twist.

The central bank plans to buy about $45 billion of Treasuries and sell about $52 billion during December, according to the statement.

Bank of America Corp., Goldman Sachs Group Inc. and Citigroup Inc. had their long-term credit grades reduced to A-from A yesterday after Standard & Poor’s revised criteria for dozens of the world’s biggest lenders.

Yield Range

Treasuries have fluctuated over the past three months as European leaders tried to convince investors that nations in the region will be able to pay their debts. The U.S. 10-year yield rose to 2.42 percent on Oct. 28, after reaching a record low 1.67 percent on Sept. 23.

The yield on U.S. 30-year bonds rose to 12 basis points above similar maturity German government securities after falling below them yesterday for the first time since May 2009.

Italian and Spanish 10-year bonds dropped relative to benchmark German securities earlier today after euro-area ministers said more work was needed to enhance the role of the International Monetary Fund in fighting Europe’s debt crisis. The region is struggling with a crisis that has already forced Greece, Ireland and Portugal to seek bailouts, and pushed yields at an Italian sale of three-year bonds yesterday to 7.89 percent.

Funding Concern

“The question is whether it’s a knee-jerk reaction,” said Richard Gilhooly, an interest-rate strategist at TD Securities Inc. in New York. “It doesn’t alleviate funding concerns for Italy. The next leg of this trade is to see Italian yields come down. Italy is not Greece or Ireland. Italy is the end of the euro if they don’t get them down.”

The yield on 10-year Italian government debt fell 16 basis points to 7.08 percent, while the difference between those securities and German bunds of similar maturity narrowed eight basis points to 4.79 percentage points. The yield on Spain’s 10-year government notes fell eight basis points to 6.32 percent, touching the lowest since Nov. 16.

The economy expanded at a “at a slow to moderate pace” led by gains in manufacturing and consumer spending, during the period covering October and the first half of November, the Fed said in its Beige Book survey released today in Washington.

Companies added 206,000 workers to payrolls in November, according to data today from Roseland, New Jersey-based ADP Employer Services.

Jobs Pattern

The median forecast of economists surveyed by Bloomberg News called for an advance of 130,000. Projections ranged from gains of 95,000 to 200,000. Last month, ADP’s initial figures showed a 110,000 gain for October, while the Labor Department’s data two days later showed an increase of 104,000 in private payrolls.

U.S. payrolls gained by 125,000 during November, according to the median forecast in a Bloomberg News survey of 82 economists.

The gap between 10-year yields on fixed-rate U.S. government debt and Treasury Inflation-Protected Securities widened to 2.06 percentage points, the most since Nov. 14. The difference in yields, known as the breakeven inflation rate, indicates the average level of increase in consumer prices traders expect during the life of the securities.

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