U.S. Five-Year NotesOutperform on Record Butterfly Spread

U.S. 5-year notes are the most expensive ever relative to 2- and 10-year securities based on the so-called butterfly spread measure of value.

The spread formed by yield gaps between the securities is tumbling, reflecting demand for the middle security over either end. The figure fell to negative 54.86 basis points on Sept. 10, the lowest closing level on record based on data that go back to 2006, and it was negative 54.61 basis points today.

The Federal Reserve has cut benchmark borrowing costs to almost zero percent, meaning holders of short-term Treasuries that track the central bank rate won’t benefit from further reductions. Meanwhile, yields show inflation expectations are rising, sparking concern long-term bonds will suffer.

“There’s limited room for short-term securities to gain,” said Kazuaki Oh’e, a debt salesman in Tokyo at CIBC World Markets Japan Inc., a unit of Canada’s fifth-largest lender. “There’s a risk in the long end because there might be inflation. You’d like to sell the wings.”

The difference between yields on 10-year notes and same-maturity Treasury Inflation Protected Securities, a gauge of trader expectations for consumer prices over the life of the debt, has widened to 2.39 percentage points from 1.95 percentage points at the end of 2011. The average over the past decade is 2.16 percentage points.

The gap between 10- and 30-year U.S. rates widened to as much as 1.18 percentage points on Sept. 10, the most since May. Thirty-year bonds, because of their long maturity, are more sensitive to inflation than shorter-term Treasuries. The difference was as much as 1.16 percentage points today.

‘Little Risk’

“There’s little risk in five-year Treasuries for the rest of this year,” said Hideo Shimomura, who helps oversee the equivalent of $76.1 billion in Tokyo as chief fund investor at Mitsubishi UFJ Asset Management Co., which is part of Japan’s largest publicly traded bank.

Fed policy makers will gather today and tomorrow amid speculation they will begin a third round of debt purchases under the bank’s quantitative-easing strategy or extend their pledge to keep interest rates at virtually zero to late 2014.

Five-year notes returned 0.2 percent in the past month, Bank of America Merrill Lynch data show. Ten-year securities fell 0.3 percent, while two-year securities rose 0.1 percent, the data show.

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