Treasuries Decline as Fed Extends Operation Twist to Year-End

Treasuries fell after the Federal Reserve said it will extend its program to replace short-term notes with longer-term debt in a bid to cut unemployment and spur growth.

U.S. government securities fluctuated earlier as German Chancellor Angela Merkel declined to commit to direct sovereign-debt purchases through the euro-area bailout fund, while saying there’s the “possibility” of purchases on the secondary market. Fed Chairman Ben S. Bernanke said policy makers are prepared to consider further asset purchases.

“The Fed is holding course and giving politicians the opportunity to resolve problems,” said Matthew Duch, a fixed-income money manager in Bethesda, Maryland, at Calvert Investments, which oversees more than $12 billion in assets. “It’s hard to make the case that you should own Treasuries in this environment, but it’s hard to be without them as well, as the level of uncertainty and lack of direction is palpable.”

The benchmark 10-year note yield rose four basis points to 1.66 percent at 5:43 p.m. in New York, according to Bloomberg Bond Trader prices. Earlier it increased to 1.68 percent and declined to 1.60 percent. The yield dropped to 1.4387 percent on June 1, the lowest on record. The price of the 1.75 percent security due in May 2022 declined 11/32, or $3.44 per $1,000 face amount, to 100 27/32.

Thirty-year bond yields were little changed at 2.74 percent. They rose six basis points earlier to 2.80 percent and fell five basis points to 2.69 percent.

Volume Increases

Trading volume climbed. About $316 billion of Treasuries changed hands as of 5:03 p.m. through ICAP Plc, the world’s largest interdealer broker, up 47 percent from yesterday’s $215 billion. The average volume over the past year is $255 billion.

Merkel, speaking to reporters after meeting Dutch Prime Minister Mark Rutte in Berlin, said there are no concrete plans on bond purchasing. Still, she said, “there is the possibility of purchasing sovereign bonds on the secondary market.”

The Federal Open Market Committee, the Fed’s policy-making group, said in a statement at the end of a two-day meeting it will expand its program to replace short-term notes with longer-term debt by $267 billion through the end of 2012. The program, dubbed Operation Twist by traders, is designed to extend the maturity of central-bank holdings to lower borrowing costs.

The extension “should put downward pressure on longer-term interest rates and help to make broader financial conditions more accommodative,” the FOMC said in the statement. The current, $400 billion Operation Twist was announced in September, when the 10-year note yielded 1.86 percent, and expires this month.

Fed Goal

“The Fed is going to continue taking long-term assets out of the marketplace,” said Bret Barker, a portfolio manager at Los Angeles-based TCW Group Inc., which manages about $128 billion in assets. “The Fed’s goal is to take volatility out of the market, keep rates low and stable, and help keep mortgage rates low. As long as they do this, the Fed is happy as can be.”

The difference in yield between two- and 30-year Treasuries was 243 basis points today. It has narrowed from 304 basis points on Sept. 20, the day before the Fed announced the plan.

Volatility in the Treasuries market dropped 11 percent to 84.7 basis points over the past two days, according to Bank of America Merrill Lynch’s MOVE index, as investors speculated the Fed would extend Operation Twist. It was the gauge’s their first back-to-back declines since May. The index measures price swings based on options.

‘Volatility Crusher’

“The Fed’s decision is a volatility crusher,” said Carl Lantz, head of interest-rate strategy in New York at Credit Suisse AG, one of 21 primary dealers that trade with the central bank. “It’s more beneficial for the long end than the intermediate sector, which means more flattening of the curve and strength in the long end.”

The Fed has helped keep the economy growing for nine-straight quarters by pumping $2.3 trillion into the financial system in two rounds of debt purchases under quantitative easing and through Operation Twist. It also has kept its key interest rate at zero to 0.25 percent since December 2008 and said it expects to keep the benchmark there through late 2014.

Fifty-eight percent of economists in a June 18 survey by Bloomberg News said the Fed would prolong Operation Twist today, and 60 percent said it probably won’t announce a third round of large-scale asset-purchases, or quantitative easing.

Forecasts Reduced

Central-bank officials lowered their forecasts for growth and raised their predictions for unemployment in each of the next three years. They now see 1.9 percent to 2.4 percent growth in 2012, down from their April forecast of 2.4 percent to 2.9 percent. The unemployment rate will end the year at 8 percent to 8.2 percent, up from 7.8 percent to 8 percent in April.

Policy makers foresee a weaker economy into 2014. The unemployment rate will end that year at 7 percent to 7.7 percent, up from a 6.7 percent to 7.4 percent in April, according to their so-called central tendency estimates, which exclude the three highest and three lowest forecasts.

“The day-to-day activity and the erratic behavior coming out of the euro zone is just overwhelming to people,” said Paul Horrmann, a broker in New York at Tradition Asiel Securities Inc., an interdealer broker. “ Everything is disturbingly unconvincing. The story is the lack of conviction, volatility and direction.”

Treasuries fell earlier today as Greek political leaders struck an agreement on a governing coalition, increasing speculation Europe’s debt crisis may be contained and decreasing refuge demand.

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

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