Treasuries Hold Gain on Concern Debt Crisis Is Deepening

Treasury 10-year note yields dropped below 2 percent for a second day amid mounting speculation the European sovereign-debt crisis is intensifying, increasing investor appetite for the safest assets.

Yields on the benchmark note touched the lowest level in more than five weeks even as a report showed retail sales in the U.S. rose more than forecast in March. Spanish bond yields reached a four-month high before debt auctions this week. A separate report showed manufacturing in the New York region expanded in April at the slowest pace in five months.

“It’s all about what’s going on in Europe, as the concerns just won’t go away, which is supporting Treasuries,” said Larry Milstein, managing director in New York of government- and agency-debt trading at R.W. Pressprich & Co., a fixed-income broker and dealer for institutional investors. “Spain is in the cross hairs as the market is getting closer to the answer of the ultimate question -- whether there will be contagion or not. Right now, everyone is cautious.”

Benchmark 10-year notes yields were little changed at 1.98 percent at 5 p.m. New York time, according to Bloomberg Bond Trader prices, after dropping seven basis points on April 13. The 2 percent security due in February 2022 changed hands at 100 6/32.

The 10-year yield touched 1.94 percent today, the least since March 7.

Japan’s 10-year rate fell one basis point to 0.94 percent, the lowest since November 2010, and German bund futures rose to a record-high 140.51 as investors sought the safest assets.

Rescue Packages

Spain is scheduled to sell 12-month and 18-month bills tomorrow, followed by auctions of debt due in October 2014 and January 2022 two days later. Yields on the nation’s 10-year notes jumped as much as 18 basis points to 6.16 percent, the highest level since Dec. 1, climbing toward the 7 percent level that pushed Greece, Ireland and Portugal to seek rescue packages.

Prime Minister Mariano Rajoy said Spain must reduce its budget deficit in order to maintain access to financing.

“The fundamental objective at the moment is to reduce the deficit,” Rajoy told a conference in Madrid today. “If we don’t achieve this, the rest won’t matter: we won’t be able to fund our debt, we won’t be able to meet our commitments.”

The difference in yield between Spanish 10-year bonds and similar-maturity German securities, Europe’s benchmark, was at 435 basis points, up from 356 basis points on March 30. German 10-year bund yields dropped two basis points to 1.7 percent today, the lowest since April 10, while Germany’s 10-year bund future today rose to a record-high as investors sought the safest assets.

‘Spanish Saga’

“The Spanish saga is taking center stage,” said Guy LeBas, chief fixed-income strategist at Janney Montgomery Scott LLC in Philadelphia, which oversees $12 billion in Fixed income assets. “There’s an ebb and flow of nervousness.”

John Paulson, the billionaire hedge-fund manager, told investors he is shorting European sovereign bonds, according to a person familiar with the matter. A short is a bet a security will drop in value.

Paulson, 56, said during a call with investors that he is also buying credit-default swaps on European debt, or protection against the chance of default, said the person, who asked not to be identified because the information is private.

Valuation measures show U.S. government debt is at the most expensive level in almost six weeks. The term premium, a model created by economists at the Fed, reached negative 0.66 percent, the most expensive since March 7. A negative reading indicates investors are willing to accept yields below what’s considered fair value.

Retail Sales

Treasuries returned 1.1 percent this month as of April 13, according to Bank of America Merrill Lynch indexes.

U.S. retail sales rose 0.8 percent last month, after a revised 1 percent gain in February, according to the Commerce Department data today.

The Federal Reserve Bank of New York’s general economic index unexpectedly decreased to 6.6 this month from 20.2 in March. The median forecast of economists in a Bloomberg News survey was for a drop to 18. Readings higher than zero in the Empire State Index signal expansion among companies.

The economy expanded “at a modest to moderate pace” from mid-February through late March as manufacturing, hiring and retail sales showed signs of strengthening, the Federal Reserve said in its Beige Book report on April 11.

Negative Real Yield

Treasury 10-year notes yield negative 0.72 percentage points after subtracting annual consumer price increases of 2.7 percent. The so-called real yield has been negative for almost a year.

The difference between yields on 10-year notes and Treasury Inflation Protected Securities, a gauge of trader expectations for consumer prices, has widened to 2.26 percentage points from 1.95 percentage points at the end of last year. The average over the past decade is 2.14 percentage points.

The five-year, five-year forward break-even rate, a measure of traders’ inflation expectations that the Fed uses to help guide monetary policy on April 11 was at 2.71 percent, below its 2.76 percent average during the past decade.

The U.S. plans to sell $16 billion of five-year TIPS on April 19. Bank of America Corp.’s TIPS index has rallied 2.2 percent this year, reflecting demand for inflation protection.

The Fed has pledged to keep its benchmark interest rate near zero until late 2014 to support growth. The U.S. central bank is also replacing $400 billion of shorter-term debt in its holdings with longer maturities to hold down borrowing costs. It is scheduled to sell as much as $8.75 billion of Treasuries due from February 2013 to June 2013 today as part of the program, according to the New York Fed’s website.

‘Low for Long’

“We continue to believe that 10-year yields are low for long,” Dominic Konstam, global head of interest-rates research in New York at Deutsche Bank AG, a primary dealer, wrote in a note to clients today. “Yields should be range bound if policy makers (rightly) err on the side of caution. The risk is that yields fall further, not rise sustainably.”

International demand for U.S. financial assets slowed in February as the European debt crisis showed signs of easing.

Net buying of long-term equities, notes and bonds totaled $10.1 billion in February, compared with net purchases of $102.4 billion in January, the Treasury Department said today in Washington. Economists surveyed by Bloomberg News projected net buying of $42.5 billion of long-term assets, according to the median estimate.

China’s Buying

China, the largest foreign lender to the U.S., increased its position in Treasuries for a second month in February, boosting its holdings $12.7 billion or 1.1 percent to $1.18 trillion.

China increased its holdings of longer-term notes and bonds by $11.9 billion, or 1 percent, to $1.175 trillion. Its stake in short-term bills rose by $800 million to $3.8 billion, Treasury data show.

Japan, the second-largest holder of U.S. Treasuries, increased its holdings in February by $13.1 billion to $1.1 trillion.

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