U.S. 10-Year Notes Drop Before Fed Decision

Treasuries fell for a second day as an agreement to form a new Greek government reduced the refuge appeal of U.S. debt and traders speculated the Federal Reserve will announce more monetary stimulus at today’s policy meeting.

Yields on 30-year bonds climbed to the highest level in a week as a Bloomberg News survey forecast the central bank will extend its Operation Twist program. Fed Chairman Ben S. Bernanke will hold a press conference at about 2:15 p.m. Washington time to explain the Federal Open Market Committee’s decision.

“The pressure is really on the back end,” said Michael Franzese, managing director and head of Treasury trading at Wunderlich Securities Inc. in New York. “The European crisis is starting to abate, and it’s taking some pressure off the equity markets. The question of twist or no twist is in the forefront of Fed watchers’ minds.”

Thirty-year bond yields climbed four basis points, or 0.04 percentage point, to 2.77 percent at 10:53 a.m. New York time, according to Bloomberg Bond Trader data. The yields, which rose seven basis points yesterday, touched 2.78 percent, the highest level since June 13. The price of the 3 percent security maturing in May 2042 slid 3/4, or $7.50 per $1,000 face amount, to 104 21/32.

Benchmark 10-year note yields increased four basis points to 1.66 percent.

More Expensive

A valuation measure showed U.S. 10-year notes declined from almost the most expensive levels ever. The term premium, a model created by economists at the Fed, was at negative 0.82 percent, after reaching a record of negative 0.94 percent on June 1 as investors sought refuge from Europe’s sovereign-debt crisis.

A negative reading indicates investors are willing to accept yields below what’s considered fair value. The average over the past decade is 0.50 percent.

Operation Twist, in which the central bank sells short-term securities and buys the same amount of longer-term debt to lengthen the average maturity of its holdings and keep borrowing costs low, is set to expire this month. The difference in yield between two- and 30-year securities was 249 basis points. It has narrowed from 304 basis points on Sept. 20, the day before the central bank announced the plan.

“No one can say with any degree of certainty what the Fed might do,” said Christopher Sullivan, who oversees $1.9 billion as chief investment officer at United Nations Federal Credit Union in New York. “Given the pace of growth in the U.S. and the failure of the U.S. economy to generate sufficient jobs to bring down the unemployment rate and inflation easing, one might feel the Fed is obligated to do more. But growth is continuing in a modest way, and the risk of contagion in Europe has eased some, so the Fed might hold some policy in reserve against a further flair up later down the road.”

Fed Expectations

Fifty-eight percent of respondents in a June 18 poll said the Fed will prolong the program, and 60 percent said the Fed probably won’t announce a third round of large-scale asset-purchases, or quantitative easing, at the meeting. Sixty-four economists responded to the Bloomberg survey.

The Fed may extend the Operation Twist program to January 2013, according to Credit Suisse Group AG analysts. That would involve Treasuries and mortgage-backed securities, the analysts, led by Carl Lantz, head of interest-rate strategy in New York, wrote in a research note yesterday.

If the Fed extended the program, the U.S. yield curve would flatten, said Eric Wand, a fixed-income strategist at Lloyds Banking Group Plc in London, meaning longer-term yields would decrease relative to shorter maturities. A third round of QE would lead to the curve steepening, he said.

Yield Forecasts

U.S. 30-year yields are projected to rise to 3.24 percent by year-end, while two-year yields may climb to 0.39 percent, according to strategist estimates compiled by Bloomberg.

Long-bond yields may struggle to climb above their June 11 high of 2.85 percent, and then at their May 22 high of 2.90 percent, according to data compiled by Bloomberg based on technical indicators.

The Fed is not alone in considering extra steps to stimulate the economy. Bank of England Governor Mervyn King and three other policy makers were overruled this month as they pushed to expand the bank’s bond-purchase program, meeting minutes showed today. European Central Bank President Mario Draghi left the door open for a rate cut at a June 6 press conference.

Treasuries returned 3.1 percent from March 30 through yesterday, according to Bank of America Merrill Lynch indexes, amid concern Europe’s debt crisis will weigh on U.S. growth. The Standard & Poor’s 500 Index lost 3.1 percent.

Greek Government

Greek political leaders struck an agreement on a governing coalition that will seek relief from austerity measures tied to emergency loans. Antonis Samaras, head of the New Democracy party, will probably be sworn in as prime minister today, said a party official who asked not to be identified.

Euro-area leaders at a Group of 20 summit that ended yesterday pledged to take “all necessary policy measures” to defend the currency union.

Bernanke said on June 7 that Europe’s situation poses “significant risks” to the U.S. economy and that the Fed was prepared to take action if necessary.

The U.S. Treasury is scheduled to announce tomorrow the amount of bonds it will auction next week. It will probably sell $35 billion of two-year notes on June 26, the same amount of five-year securities the next day and $29 billion of seven-year debt on June 28, according to Wrightson ICAP LLC, an economic advisory company in Jersey City, New Jersey.

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