Treasury Yields Drop to Records as Europe Spurs Haven Bid

PIMCO Fund Manager Bill Gross
Bill Gross, fund manager at Pacific Investment Management Co.. Photographer: Tim Boyle/Bloomberg

Treasuries climbed, with five-, 10-and 30-year yields sliding to records, as concern mounted that Greece’s failure to meet bailout targets may worsen the European debt crisis, stoking demand for the safest assets.

The yield on the 10-year note plunged below the old mark set June 1 before the meeting tomorrow of Greece’s troika of international creditors, while the cost of insuring Spain’s debt rose to a record. The benchmark note extended gains after Moody’s Investors Service lowered to negative the Aaa credit-rating outlooks on Germany, the Netherlands and Luxembourg. U.S. government debt added to last week’s rise before reports this week forecast to show growth cooled.

“Money is fleeing every place in the world and then coming here,” said Thomas Roth, senior Treasury trader in New York at Mitsubishi UFJ Securities USA Inc. “The path of least resistance is to lower yields. It’s all driven by Europe.”

The benchmark 10-year yield fell three basis points, or 0.03 percentage point, to 1.43 percent at 5 p.m. in New York. The 1.75 percent note due in May 2022 rose 9/32, or $2.81 per $1,000 face amount, to 102 30/32. The yield fell to as low as 1.3960 percent, with the five-year rate dropping to 0.5411 percent and the 30-year yield sliding to 2.4752 percent.

The 10-year record compares with an average of 3.76 percent over the past 10 years, according to data compiled by Bloomberg.

Volume, Volatility

Treasury trading volume reported by ICAP Plc, the largest inter-dealer broker of U.S. government debt, was at $204 billion, trading below the $241 billion average this year.

Volatility was little changed today at 61.6 basis points, almost the lowest since May 10, according to Bank of America Merrill Lynch’s MOVE index. It dropped to a five-year low of 56.7 basis points on May 7, and has averaged 75.6 basis points this year, touching a 2012 high of 95.4 basis points on June 15. It reached a record high of 264.6 basis points in October 2008 as the financial crisis intensified. The index measures price swings based on options.

The Federal Reserve today purchased $4.779 billion of Treasuries due from July 2018 to June 2019 as part of a program known as Operation Twist, in which it swaps short-term bonds in its holdings for longer maturities to push long-term borrowing costs lower.

The central bank bought $2.3 trillion of mortgage and Treasury debt from 2008 to 2011 in two rounds of so-called quantitative easing, seeking to stimulate the economy.

Excessive Fed buying of Treasuries may reduce liquidity by leaving less for private investors to buy, said Nathan Sheets, global head of international economics at Citigroup Inc. Central bank Chairman Ben S. Bernanke instead may favor buying mortgage-backed securities or using new tools for easing, he said.

‘Financial Stability’

Purchasing too many Treasuries may “have a serious long-term effect on the market,” Sheets, who until last August was the Fed’s top international economist, said in a phone interview. “The Fed implicitly has a mandate for financial stability, and as part of that they’re concerned about ensuring the functioning and integrity of financial markets.”

The Federal Open Market Committee next meets on July 31 and Aug. 1. While policy makers refrained from introducing a third round of asset purchases at their meeting last month, Bernanke indicated in two days of testimony in Washington last week that it’s an option. The benchmark rate has been in a range between zero and 0.25 percent since December 2008.

Valuation measures show U.S. sovereign securities are at the most costly levels ever. The term premium, a model created by economists at the Fed, surpassed negative 1.01 percent, the all-time most expensive. A negative reading indicates investors are willing to accept yields below what’s considered fair value.

‘Forced’ Buying

Treasuries returned 1.2 percent this month after a 0.4 percent loss in June, according to Bank of America Merrill Lynch indexes.

“No one in the dealer community thinks yields are attractive,” said Brian Edmonds, head of interest rates in New York at Cantor Fitzgerald LP, one of 21 primary dealers that trade with the Fed. “It’s more of a trade where people are being forced to buy.”

The U.S. will sell $35 billion of two-year notes, the same amount of five-year securities and $29 billion of seven-year debt over three days starting tomorrow.

Ten-year U.K., Finnish and Canadian rates today fell to the lowest on record, as did German two-year note yields. Japan’s five-year yield slid to the least since 2003.

Spain, Italy

German bunds advanced after El Pais reported, without citing anyone, that six Spanish regions may ask for aid from the central government, and speculation grew that Greece will miss its bailout targets. German government bonds handed investors a 2.6 percent return this month, according to Bank of America Merrill Lynch indexes.

Credit-default swaps on Spain jumped as much as 31 basis points to 636, according to data compiled by Bloomberg, and were at 632 at 1:30 p.m. in London. A basis point on a swap protecting 10 million euros ($12 million) of debt from default for five years is equivalent to 1,000 euros a year. Yields on 10-year bonds surged over 7.5 percent.

Spain and Italy placed short-sale bans on stock. A three-month bar was placed on trades that “constitute or increase net short positions on shares” in the Spanish market due to “extreme volatility” in European markets, Spain’s CNMV regulator wrote in e-mailed statement. Italy’s Consob placed a one-week prohibition on the practice on 29 banking and insurance shares, citing “grave tensions” in markets.

Greek ‘Exit’

Greece will host a visit beginning tomorrow from the troika of international creditors -- the European Commission, the European Central Bank and the International Monetary Fund. The nation is struggling to meet obligations tied to the 240 billion euros of rescue funding it has received over the past two years as efforts to reduce its debt to 120 percent of gross domestic product by 2020 fall short.

“Greece presumably is going to have to exit the euro,” said David Ader, head of U.S. government-bond strategy at CRT in Stamford, Connecticut. “With the troika meeting tomorrow, there’s a real sense they will come away with nothing. And that’s being reflected in the downward pressure in yields and in the euro.”

Billionaire hedge-fund manager John Paulson told clients today he sees a 50 percent chance that the euro will break up, said an investor who listened to the comments. Paulson, who runs Paulson & Co. in New York, said on a conference call he expects sovereign spreads to widen, according to the investor, who asked not to be named because the call was private. Armel Leslie, a spokesman for the fund, declined to comment.

Economic Data

Figures from London-based Markit Economics scheduled for tomorrow will show a composite index based on a survey of purchasing managers in manufacturing and services in the euro area was unchanged at 46.4 this month from June, according to economists in a Bloomberg survey. A reading below 50 indicates contraction.

The U.S. economy grew at an annualized 1.4 percent in the second quarter, according to a Bloomberg News survey before the Commerce Department report on July 27. That would be the slowest pace since the period ended June 2011 and compares with a 1.9 percent rate in the first quarter of this year.

“We are stuck in a soft patch and there isn’t a lot that can be done to change that in the near term,” said Dominic Konstam, global head of interest-rates research in New York at primary dealer Deutsche Bank AG. “The consumer continues to lose confidence.”

‘Downside Limit’

Bill Gross, who runs the world’s top bond fund at Pacific Investment Management Co., wrote on Twitter that real assets are a “better bet” amid negative real interest rates.

Investors may be able to maintain purchasing power with real assets, Gross wrote. Real assets include inflation-linked bonds, commodities, real estate or some combination of those assets, according to the company’s website. Gross’s $263 billion Total Return Fund had 52 percent of its assets in mortgage-related bonds and 35 percent in Treasuries as of June 30, the website showed.

The cost of living in the U.S. rose 1.7 percent in June from a year earlier, according to a July 17 report. The difference between the consumer-price rate and the 10-year Treasury yield, the so-called real yield, was minus 29 basis points at the note’s current level.

The world’s biggest fixed-income investors are increasing holdings of corporate debt as a haven from the negative real yields on government debt from the U.S., the U.K. and Germany.

BlackRock Inc., Glenmede Corp. and at least four other firms that collectively manage in excess of $4 trillion are putting more of their money into the bonds of companies, contributing to a record rally.

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