U.S. Inflation Bets Set for 2nd-Biggest Weekly 2012 Gain

The yield spread between 10-year notes and inflation-linked bonds was set to complete the second-biggest weekly gain this year before U.S. data that may show hiring increased amid monetary easing by the central bank.

Federal Reserve Bank of St. Louis President James Bullard said measures of inflation expectations indicate bond holders have doubts the Fed will hold price increases within its 2 percent goal. Demand for Treasuries was supported ahead of reports that economists said will show German factory orders and the euro region’s industrial production decreased.

“The Fed’s easing is raising inflation expectations,” said Shinji Kunibe, chief portfolio manager for fixed-income investment in Tokyo at Nissay Asset Management Corp., which oversees the equivalent of $65 billion. “Pricing-in risk premiums on inflation, the yield curve will gradually steepen,” he said, referring to a faster gain in longer-maturity yields than that in shorter-term rates.

The yield gap between 10-year notes and similar-maturity inflation-linked bonds, a gauge of expectations for consumer prices, widened 20 basis points this week to 2.62 percentage points. It’s poised for the biggest increase this year after a gain of 27 basis points in the week ended Sept. 14.

The yield on 10-year notes was little changed at 1.67 percent as of 6:35 a.m. in London. It earlier rose to 1.68 percent, the highest level since Sept. 25. The 1.625 percent security due August 2022 added 1/32, or 31 cents per $1,000 face amount, to 99 19/32, according to Bloomberg Bond Trader data.

Japan’s bonds were little changed as the central bank kept monetary policy unchanged. Five-year note yields were at 0.195 percent, while 10-year rates were at 0.775 percent. Thirty-year yields added 1 1/2 basis points to 1.92 percent, the highest since Sept. 21.

U.S. Jobs

U.S. payrolls rose by 115,000 in September, up from 96,000 the prior month, the Labor Department may report today, according to the median forecast of economists surveyed by Bloomberg News. The jobless rate is estimated at 8.2 percent, compared with 8.1 percent in August.

Applications for jobless benefits rose by 4,000 to 367,000 in the week ended Sept. 29, government figures showed yesterday. Economists had forecast an increase to 370,000.

The Fed unveiled a third round of so-called quantitative easing last month with open-ended purchases of $40 billion a month in mortgage-backed securities. In the first two rounds, the central bank bought Treasury and mortgage debt valued at $2.3 trillion.

Inflation Outlook

Treasury Inflation-Protected Securities “seem to suggest that investors do not completely trust the Fed to deliver on its 2 percent inflation target,” Bullard said yesterday in a speech in Memphis, Tennessee.

“The Fed is uber-dovish right now,” said Aaron Kohli, an interest-rate strategist in New York at BNP Paribas SA, one of 21 primary dealers that trade with the central bank. “The Fed’s going to be very focused on its job creation given they feel they have a very strong hold on their inflation mandate.”

Ten-year yields were still about 30 basis points from a record low amid increasing signs that the prolonged debt crisis in the euro area is hurting the region’s economies.

Government data today may show today German factory orders slid 0.5 percent in August from the previous month, economists forecast. Industrial production in the currency bloc is projected to have fallen 0.3 percent in August from July, according to economist estimates compiled before the figure is released on Oct. 12.

‘Further Deterioration’

“The euro region’s economy is undoubtedly on a path to further deterioration,” giving downward pressure on Treasury yields in the longer term, said Kunibe of Nissay Asset.

Ten-year Treasury rates touched the all-time low of 1.38 percent on July 25.

Bank of America Merrill Lynch’s MOVE index, which measures price swings based on the implied volatility of Treasury options, was at 59.8 basis points yesterday. It fell to 57.5 basis points on Sept. 19, the lowest since May.

“We expect the decline of implied volatility to slow down now, although volatility may keep trading at current cheap levels for some time,” Ciaran O’Hagan, head of European rates strategy at Societe Generale SA in Paris, wrote in a research note yesterday. “Those in need of a hedge should find current levels of implied volatility quite attractive.”

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