Treasuries Fall as Yields Damp Demand Before Auctions

Treasuries fell, pushing 10-year note yields up from almost a record low, as investors bet price gains were overdone before the U.S. sells $99 billion of coupon-bearing debt next week.

Benchmark notes posted a ninth weekly gain, the longest streak since 1998, after Moody’s Investors Service cut the credit ratings of 16 Spanish banks, citing economic weakness and the government’s mounting budget strain, and Fitch Ratings downgraded Greece. The 10-year yield erased gains earlier as investors’ reluctance to hold bets on falling prices into the weekend boosted demand for the safety of U.S. debt.

“The fear trade lingers,” said Thomas Roth, senior Treasury trader in New York at Mitsubishi UFJ Securities USA Inc. “If anybody’s short, they probably don’t want to go home short for the weekend.” A short position is a bet that an asset will decrease in value.

The 10-year yield rose two basis points, or 0.02 percentage point, to 1.72 percent at 5 p.m. in New York, according to Bloomberg Bond Trader prices. The 1.75 percent note due in May 2022 fell 7/32, or $2.19 per $1,000 face amount, to 100 8/32.

The yield rose as much as four basis points. It dropped as low as 1.6937 percent, approaching the record low 1.6714 percent set Sept. 23. It has declined 12 basis points this week.

Thirty-year bond yields climbed two basis points to 2.81 percent after rising as much as six basis points.

Gain Streak

Treasuries gained for nine weeks through the week ended Oct. 2, 1998, as investors sought safety amid a decline in the value of Asian currencies, a default by Russia on its sovereign debt and the collapse of hedge fund Long-Term Capital Management LP.

The 10-year note yield has fallen from 2.29 percent since the week ended March 16, a 57 basis point decline. During that period Treasuries have returned 3.2 percent, including reinvested interest, according to Bank of America Merrill Lynch bond indexes, compared with a 7 percent decline for the Standard & Poor’s 500 stock index during the period.

Next week’s auctions will consist of $35 billion each of two-year and five-year securities and $29 billion of seven-year notes over three days starting May 22.

“Demand may be lower,” said Kevin Yang, head of bond investment in Taipei at Hontai Life Insurance Co., which has $6 billion in assets. “They’re expensive. The economy in the U.S. is not so weak. It’s stable.” He trimmed his Treasury holdings yesterday, he said.

Economic Outlook

The U.S. economy will expand 2.3 percent this year, compared with 1.7 percent in 2011, a Bloomberg News survey of banks and securities companies shows. Euro-area gross domestic product will shrink 0.3 percent, versus last year’s 1.5 percent growth rate, according to the estimates.

Fed Bank of St. Louis President James Bullard said yesterday economic reports this year have been stronger than forecast and he expects the central bank to raise its target interest rate by 2013. Bullard doesn’t vote on monetary policy this year.

The Fed bought $4.9 billion of Treasuries due from August 2020 to February 2022 today, according to the Fed Bank of New York’s website. The purchases are part of the central bank’s program to replace $400 billion of shorter-term debt in its holdings with longer maturities by the end of June to help keep down borrowing costs.

Fed policy makers may find another round of Operation Twist is preferable to an outright asset-purchase program should the economy show further signs of weakness or if risks increase.

Fed Policy

Chairman Ben S. Bernanke on April 25 said he was prepared to take further action to aid the economy if necessary, even as he signaled he didn’t see an immediate need to add stimulus with inflation near the Fed’s goal and unemployment falling. And the minutes from the Fed’s April meeting showed several policy makers said additional action could be necessary if the recovery slips.

Economists such as Nathan Sheets, Global Head of International Economics at Citigroup Inc. and Credit Suisse Securities’ Dana Saporta said the Fed’s $400 billion program to extend the maturity of bonds has been just as effective as earlier programs to expand its balance sheet, known as quantitative easing.

Yields have tumbled this week in the highest-rated debt markets. German, two-, five-, 10- and 30-year yields all dropped to records today as turmoil in Greece and Spain spurred demand for the safest government securities. Japanese government bond yields declined the lowest level since July 2003.

Spain’s Debt

Moody’s cut the ratings of Spain’s biggest lenders including Banco Santander SA and Banco Bilbao Vizcaya Argentaria SA yesterday. The move followed the company’s May 14 downgrade of 26 Italian banks and its Feb. 13 cut of Spain’s sovereign debt. The main drivers for the bank downgrades were a surge in soured loans, the recession, restricted funding access and the reduced ability of the government to support lenders, Moody’s said.

The market’s desire try to push yields to record lows on the 10-year note will depend on events, said Kevin Flanagan, a Purchase, New York-based fixed-income strategist for Morgan Stanley Smith Barney.

“Unless you see further negative headlines, perhaps we can hold in here, but that’s a big perhaps,” Flanagan said. “It’s a purely headline-driven market.”

Yield Forecasts

Market participants are cutting their yield forecasts. The 10-year yield will be 2.48 percent by year-end, a Bloomberg survey of banks and securities companies shows. The projection declined from last month’s high of 2.58 percent.

The difference between two- and 10-year yields shrank to 1.39 percentage points yesterday, the narrowest since December 2008. The spread widened today to 1.43 percentage points.

The spread between yields on 10-year notes and similar-maturity Treasury Inflation Protected Securities, a gauge of trader expectations for consumer prices during the life of the debt, contracted to 2.04 percentage points yesterday from this year’s high of 2.45 percentage points in March.

Hedge-fund managers and other large speculators increased their net-short position in 10-year note futures in the week ending May 15, according to U.S. Commodity Futures Trading Commission data.

Speculative short positions, or bets prices will fall, outnumbered long positions by 163,392 contracts on the Chicago Board of Trade. Net-short positions rose by 30,664 contracts, or 23 percent, from a week earlier, the Washington-based commission said in its Commitments of Traders report.

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