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Treasury Yields Drop to Year Low as European Crisis Intensifies

Treasuries rose, pushing yields to the lowest levels this year, as France was stripped of its top credit rating and talks to restructure Greek’s debt stalled, boosting demand for the safety of U.S. government debt.

The yield on the benchmark 10-year note touched the lowest level since Dec. 20 yesterday and the Treasury drew record demand at three- and 10-year note auctions this week. A model created by economists at the Federal Reserve that includes expectations for interest rates, growth and inflation indicates 10-year notes are the most overvalued on record.

“The story is still about mostly what’s going on in Europe,” said Jason Rogan, director of U.S. government trading at Guggenheim Partners LLC, a New York-based brokerage for institutional investors. “You still have nervousness and that’s bringing a good flight to quality trade here in the states.”

The benchmark 10-year note yield dropped nine basis points, or 0.09 percentage point for the week, to 1.87 percent yesterday in New York, according to Bloomberg Bond Trader prices. The 2 percent note due in November 2021 rose 27/32, or $8.44 per $1,000 face amount, to 101 16/32. The yield dropped six basis points yesterday.

The so-called term premium model reached a record negative 0.7 percent yesterday, compared with the average of positive 0.60 percent the past decade. The previous record was negative 0.67 percent reached Sept. 22. A negative reading indicates investors are willing to accept yields below what’s considered fair value.

Credit Ratings

Germany, Belgium, Estonia, Finland, Ireland, Luxembourg and the Netherlands had their ratings affirmed by S&P as France lost its AAA rating. France was cut to AA+ and the rating has a negative outlook, S&P said in a statement.

Cyprus, Italy, Portugal, and Spain were cut by two notches S&P said. The long-term ratings on Austria, Malta, Slovakia, and Slovenia were cut one notch.

Volatility in the Treasury market is near its lowest level in almost seven months. Bank of America Merrill Lynch’s MOVE index, which measure price swings in Treasuries based on prices of over-the-counter options maturing in two to 30 years, dropped to 77.1 basis points on Jan. 12, the lowest point since June 13. The 2011 average was 94.14, with a high of 117.8 on Aug. 8 and a low of 71.5 on May 31.

Treasury market volumes remain below average. About $268 billion of Treasuries changed hands yesterday through ICAP Plc, the world’s largest interdealer broker, below the one-year average of $282 billion.

Record-Setting Auctions

The U.S. sold $66 billion in Treasuries this week, including $13 billion of 30-year bonds at lower-than-average demand on Jan. 12 after record-setting auctions the prior two days.

The $21 billion sale of 10-year notes Jan. 11 was sold at a record low yield of 1.90 percent amid early speculation that France may lose its top credit rating. The bid-to-cover ratio was 3.29, versus an average of 3.11 for the past 10 auctions.

The government attracted record demand at its $32 billion sale of three-year notes on Jan. 10. That auction’s bid-to-cover ratio was 3.73, the highest since at least 1993, when the government began releasing the data.

“It’s one of the only things left for people to buy if you are afraid of Europe falling apart, so it’s putting tremendous amount of bids into our market,” said Thomas Roth, senior Treasury trader in New York at Mitsubishi UFJ Securities USA Inc. “We’ve definitely benefited from that.”

Retail Sales

The week’s offerings of note and bond auctions raised $30.5 billion of new cash as $35.5 billion of maturing securities are held by the public, according to Treasury Department data.

Yields dropped earlier this week after reports showing a slowdown in retail sales and a rise in jobless claims renewed concerns economic growth is stalling.

Sales at U.S. retailers in December rose 0.1 percent. The gain followed a 0.4 percent advance in November that was more than initially reported, Commerce Department figures showed Jan. 12. Economists forecast a 0.3 percent December rise, according to the median estimate in a Bloomberg News survey. Purchases excluding automobiles fell 0.2 percent.

Jobless claims climbed by 24,000 to 399,000 in the week ended Jan. 7, Labor Department figures showed the same day. The median forecast of 46 economists in a Bloomberg News survey projected 375,000.

“The numbers disappoint,” said Steven Ricchiuto, chief economist in New York at Mizuho Securities USA. “We’re not out of the woods here yet. There’s no reason to be selling Treasuries.”

Growth Forecasts

A report on Jan. 19 is forecast to show prices rose by 0.1 percent in December, after being unchanged the previous month.

Federal Reserve Bank of Richmond President Jeffrey Lacker yesterday said the U.S. economy will grow between 2 percent and 2.5 percent this year. Economists surveyed by Bloomberg News this month predict the economy will expand 2.3 percent, according to the median estimate. Fed officials estimated in November that growth of 2.4 percent to 2.7 percent is needed to absorb unused productive capacity.

The central bank purchased $6.9 billion in Treasuries due from 2020 to 2041 this week and sold $17.48 billion of securities maturing in 2012 and 2013. It also purchased $1.39 billion of Treasury Inflation Protected Securities maturing from 2018 to 2041.

It will buy about $45 billion of Treasuries in January and sell about $44 billion as part of a program, known by traders as Operation Twist, to replace $400 billion of shorter maturities in its holdings with longer-term debt to cap borrowing costs.

German Yields

Treasury 10-year notes yielded 10 basis points more than bunds yesterday after German yields dropped ahead of the downgrades. U.S. 10-year securities yielded 53 basis points more than bunds in January 2011. The yield on the 10-year bund yesterday dropped to 1.74 percent, the lowest since Nov. 15.

Greece’s creditor banks yesterday broke off talks after failing to agree with the government about how much money investors will lose by swapping their bonds, increasing the risk of the euro-area’s first sovereign default.

“Europe is a structural situation, which will not be resolving itself easily or in a short time frame,” said Chris Ahrens, the Stamford, Connecticut-based head interest-rate strategist at UBS AG, one of 21 primary dealers required to bid in U.S. Treasury auctions. “We’ll be wrestling with this for many months to come.”

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