Treasuries Gain Most in Week as Manufacturing Contracts

Yields on Treasury 10- and 30-year debt declined the most in a week after an industry report showed U.S. manufacturing unexpectedly contracted in June, spurring concern the economic recovery is floundering.

Government securities pared losses posted June 29 after euro-area leaders expanded steps to stem the bloc’s debt crisis, which damped demand for the safest assets. The Federal Reserve bought $1.81 billion of U.S. government securities in the first transaction since policy makers expanded the Operation Twist program through the end of the year to help cap borrowing costs.

“A recession isn’t going to happen in the next few months, but clearly the global economy has lost momentum,” said Guy Haselmann, an interest-rate strategist in New York at Bank of Nova Scotia, one of the 21 primary dealers that trade with the Fed. “The risks to Treasuries are for lower yields for the remainder of the year.”

The benchmark 10-year note yield fell six basis points, or 0.06 percentage point, to 1.59 percent, at 5 p.m. in New York, according to Bloomberg Bond Trader prices. It earlier declined as much as nine basis points. The 30-year bond yield slid six basis points to 2.70 percent after dropping as much as 10 basis points. The rate climbed eight basis points on June 29.

The 10-year yields fell seven basis points on June 25 while 30-year bond declined nine basis points the same day.

The Institute for Supply Management’s factory index fell to 49.7 in June from 53.5 a month earlier, the Tempe, Arizona-based group’s report showed. Readings less than 50 signal contraction, and the median forecast of economists surveyed by Bloomberg News called for a decline to 52.

As separate data this week is forecast to show employers added fewer than 100,000 jobs for a third month, another sign the world’s largest economy is cooling.

Fed Purchases

“It underscores the slowdown domestically as well as abroad,” 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. “We are still being driven by the politics in Europe. We took a step on Friday, but it was just a small step. The devil is in the details with Europe more so than in the U.S. You don’t want to be short Treasuries.”

The Fed purchased as part of Operation Twist Treasuries due from February 2036 to May 2042 today as investors submitted $3.588 billion in offers to sell bonds, or 1.98 times the amount the central bank bought, according to the Fed Bank of New York’s website.

Investors have scaled back their offers to sell in each month since March, when they submitted 3.16 times the securities purchased by the Fed. Submissions fell to 2.92 times in April, 2.82 times in May and 2.48 times in June, Fed data show.

No Change

The central bank last month extended the plan, originally set to replace $400 billion of shorter-maturity Treasuries in its holdings with longer-term debt through June, by $267 billion through the end of 2012.

The difference in yields between 10-year notes and TIPS, which represents traders’ expectations for the rate of inflation over the life of the securities and is known as the break-even rate, was 2.08 percentage points, down from the 2012 high of 2.45 percentage points on March 20. It touched a 2012 low of 1.9 percentage points on Jan. 3.

The EU’s efforts to contain the debt crisis at a summit in Brussels last week weren’t enough to change Barclays Plc’s view that U.S. borrowing costs will stay low, the company wrote in a note to clients.

“We do not expect Friday’s selloff to continue,” Anshul Pradhan and Vivek Shukla, analysts at Barclays in New York, wrote in their fixed-income outlook today. “This does not change our low-for-long rates view.”

‘Further Slowdown’

Gains in Treasuries were tempered amid speculation the European Central Bank will this week take steps to address the debt crisis after a report affirmed euro-region manufacturing contracted for the 11th month in June.

ECB officials will lower their main refinancing rate by 25 basis points to a record low 0.75 percent on July 5, according to a Bloomberg survey of 57 economists. Five predict a cut of 50 basis points and 12 foresee no change.

European Union leaders agreed at their June 28-29 summit to loosen bailout rules, lay the foundations for a banking union and break the link between sovereign and banking debt through the direct recapitalization of lenders.

“We could see a significant further slowdown in the economy,” said Larry Dyer, a U.S. interest-rate strategist in New York with HSBC Holdings Plc, a primary dealer. “There may be a bit of room for the Fed to go further, but it’s limited in Treasury space. If they did need to go for another shot, it would be a case of going to the mortgage market.”

Volatility, Volume

The average rate for a 30-year mortgage has fallen to 3.66 percent from 5.59 percent in June 2009, according to a Freddie Mac survey.

The gap between the yield on the current coupon Fannie Mae mortgage security and the Treasury 10-year note has narrowed to 0.92 percentage point from 1.07 percentage points June 1. The spread has averaged 0.98 percentage point in the past 12 months.

Treasury volatility climbed for the first time in two weeks following the European announcements, according to Bank of America Merrill Lynch’s MOVE index. The gauge rose to 73.2 on June 29 from 70.2 on June 28. The reading has tumbled from 95.4 on June 15, this year’s high.

Treasury Demand

Trading volume jumped. About $280.6 billion of Treasuries changed hands on June 29 through ICAP Plc, the world’s largest interdealer broker, the highest level since touching $317 billion on June 20. Volume reached $396 billion on May 31, the highest level since March. The daily average over the past year is $251 billion.

Investors are plowing cash into new U.S. Treasuries at a record pace, making economic growth rather than budget austerity a key issue as incumbent Barack Obama and Mitt Romney face off in November’s presidential election.

Bidders offered $3.16 for each dollar of the $1.075 trillion of notes and bonds auctioned by the Treasury Department this year as yields reached all-time lows, above the previous high of $3.04 in all of 2011, according to data compiled by Bloomberg. The so-called bid-to-cover ratio was 2.26 from 1998 to 2001 when the nation ran budget surpluses.

Romney and fellow Republicans have assailed Obama for presiding over an increase in U.S. publicly owned debt to $10.5 trillion from $5.75 trillion in 2009 amid the worst financial crisis since the Great Depression. The bond market is showing growing investor confidence in the safety of dollar assets.

Dollar ‘Haven’

The dollar is a “haven and if you’re going to buy dollars you’re by and large going to be investing in Treasuries,” James Kochan, chief fixed-income strategist in Menomonee Falls, Wisconsin, at Wells Fargo Funds Management LLC, which manages $232 billion, said in a June 28 telephone interview. “They’re really one and the same trade.”

U.S. government securities have returned 1.7 percent this year, compared with a 2.5 percent gain by global government debt, excluding the U.S., according to Bank of America Merrill Lynch indexes.

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