Treasuries Drop as Reports Showing Economic Strength Damp Demand

Treasuries fell in the first week of the year as reports showed gains in U.S. factory output and jobs, trimming the haven appeal of government securities even as rising yields on Italian and Spanish debt indicated concern Europe’s debt crisis may widen.

U.S. debt yields pared a weekly gain yesterday after Federal Reserve Bank of New York President William Dudley said more monetary accommodation to bolster the economy is appropriate, even after employers added 200,000 positions during December. A report on Jan. 12 is forecast to show retail sales rose and the U.S. will auction $66 billion in three, 10- and 30-year debt next week.

“The U.S. economy continues to show good signs,” said Jason Rogan, director of U.S. government trading at Guggenheim Partners LLC, a New York-based brokerage for institutional investors. “It will be important to see if yields stay around here, if that will entice people to take down that supply.”

The benchmark 10-year note yield rose eight basis points, or 0.08 percentage point for the week, to 1.96 percent in New York, according to Bloomberg Bond Trader prices. The 2 percent note due in November 2021 dropped 23/32, or $7.19 per $1,000 face amount, to 100 3/8. The yield dropped four basis points yesterday.

The 30-year yield added 12 basis points to 3.02 percent.

Debt Returns

U.S. government securities handed investors a 0.5 percent loss this month as of Jan. 5, after returning 9.8 percent last year, Bank of America Merrill Lynch data show.

Yields on 10-year debt traded in a 36-basis-point range since November, with a high of 2.16 percent and a low of 1.8 percent. The yield range was 210 basis points for all of 2011.

Hedge-fund managers and other large speculators reversed to a net-long position in 10-year note futures in the week ending Jan. 3, according to U.S. Commodity Futures Trading Commission data.

Speculative long positions, or bets prices will rise, outnumbered short positions by 6,236 contracts on the Chicago Board of Trade. The previous week, traders were net-short 2,981 contracts.

The U.S. 10-year yield will increase to 2.66 percent by the end of 2012, according to the average forecast in a Bloomberg News survey of banks and securities companies, with the most recent projections given the heaviest weightings.

European Developments

U.S. yields ticked up even as the euro fell to a 15-month low against the dollar and Italy’s 10-year bond yields climbed above the 7 percent level that preceded bailouts for Greece, Ireland and Portugal from the European Union and the International Monetary Fund.

Spain’s 10-year yields posted their biggest weekly increase in almost 17 years, climbing by 62 basis points this week.

“The euro broke down to new lows, but there wasn’t any of that fear resonating throughout the market,” said Rogan of Guggenheim Partners. “Europe was at least somewhat quiet.”

Yields curbed weekly losses yesterday as Dudley called on the U.S. government to try new programs to revive the housing market while saying the central bank may still consider ways to cut interest rates.

“Implementing such policies would improve the economic outlook and make monetary accommodation more effective,” Dudley said in a speech to bankers in Iselin, New Jersey. At the same time, it’s “appropriate” for the Fed to consider steps to ease monetary policy, he said. The Federal Open Market Committee meets Jan. 24-25.

FOMC Preview

“Maybe Dudley’s comments are an early glimpse of what’s coming at the FOMC meeting,” said George Goncalves, head of interest-rate strategy at Nomura Holdings Inc., one of 21 primary dealers that trade Treasuries with the Fed. “The doves will try to dominate. They can try to talk the markets into believing they will be on hold for longer.”

Minutes released Jan. 3 of the Federal Reserve’s Dec. 13 policy meeting said policy makers for the first time will make public their own forecasts for the federal funds rate beginning at the Jan. 24-25 meeting. Fed officials will show investors their forecast for the benchmark interest rate in the fourth quarter of 2012 and the next few calendar years, the minutes said.

The central bank purchased $4.93 billion in Treasuries due in 2018 and 2019 this week and sold $8.7 billion of securities maturing in 2013. It also sold $1.35 billion of Treasury Inflation Protected Securities.

It will buy about $45 billion of Treasuries in January and sell about $44 billion as part of the program, known by traders as Operation Twist after a similar effort in the 1960s.

Jobs Update

A report yesterday showed gains in jobs last month after an increase of 100,000 positions the previous month, the Labor Department said in Washington. The median forecast of 81 economists in a Bloomberg News survey was for an increase of 155,000 jobs. The jobless rate fell to almost a three-year low 8.5 percent.

A report Jan. 3 showed manufacturing in the U.S. expanded in December at the fastest pace in six months. The Institute for Supply Management’s factory index climbed to 53.9 last month from 52.7 in November, the Tempe, Arizona-based group’s data showed. Fifty is the dividing line between growth and contraction, and economists surveyed by Bloomberg News forecast the gauge would rise to 53.5.

A report Jan. 12 is forecast to show retail sales rose by 0.3 percent, compared with 0.2 percent the previous month, according to the median forecast of 56 economists in a Bloomberg News survey.

The Treasury will sell $32 billion in three- year notes, $21 billion in 10-year securities and $13 billion in 30-year bonds in three consecutive days starting Jan. 10.

“It will be absorbed really well,” said Michael Franzese, managing director and head of Treasury trading at Wunderlich Securities Inc. in New York. “There are tensions all over the globe right now. Everybody is still in a wait-and-see mode.”

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