Treasury Real Yields Turn Positive as Inflation Slows

Treasury Real Yields Turn Positive as Quarterly Inflation Slows
The Federal Reserve in its last meeting before the Nov. 6 presidential election, retained its program of $40 billion in monthly purchases of mortgage-backed debt aimed at spurring the three-year economic expansion. Photographer: Andrew Harrer/Bloomberg

Treasury 10-year note yields exceeded the Federal Reserve’s preferred inflation gauge for the first time since 2011 as a report showed price increases slowed during the third quarter.

Yields on the benchmark debt traded close to a five-week high as Treasury sold $99 billion of notes this week. They fell yesterday as European-debt concern resurfaced after Spain’s jobless rate exceeded 25 percent. The Fed, in its last meeting before the Nov. 6 presidential election, retained its program of $40 billion in monthly purchases of mortgage-backed debt aimed at spurring the three-year economic expansion. A report Nov. 2 is forecast to show the U.S. added 125,000 jobs this month while the unemployment rate increased to 7.9 percent, according to economists in a Bloomberg News survey.

“We’ve seen a rise in real yields as the market’s focus has shifted away from risk aversion tied to Europe and has started to focus on domestic issues,” said Adrian Miller, a fixed-income strategist at GMP Securities LLC in New York, said. “Everyone expects inflation to be a problem down the road, but those problems aren’t here yet and inflation continues to wane. The slow growth story and uncertainty about the direction of the recovery is still front end center.”

The benchmark 10-year yield dropped one basis point this week, or 0.01 percentage point, to 1.75 percent in New York, after rising as much as 1.85 percent, the highest level since Sept. 17, according to Bloomberg Bond Trader prices. The 1.625 percent note due in August 2022 climbed 5/32, or $1.56 per $1,000 face amount, to 98 29/32.

Futures Swap

Hedge-fund managers and other large speculators reversed to a net-short position in two-year note futures in the week ended Oct. 23, according to U.S. Commodity Futures Trading Commission data. Speculative short positions, or bets prices will fall, outnumbered long positions by 5,546 contracts on the Chicago Board of Trade. Last week, traders were net-long 46,170 contracts.

Traders decreased net-long position in 10-year note futures. Speculative long positions outnumbered short positions by 79,296 contracts on the Chicago Board of Trade. Net-long positions fell by 56,669 contracts, or 42 percent, from a week earlier.

The yield on the 10-year Treasury note was greater than the pace of core consumer price increase during the third quarter for the first time since December as yields exceed consumer price gains by 45 basis points, according to Bloomberg data.

Inflation Levels

Inflation measured by the personal consumption expenditures index, a gauge preferred by Fed, rose 1.3 percent in the third quarter from a year earlier, less than the central bank’s goal of 2 percent, according to data from the Commerce Department yesterday in Washington.

Negative real yields were in place during the second quarter when the PCE figure of 1.7 percent exceeded the yield on the 10-year note of 1.65 percent by five basis points. At the end of the first quarter, both leveled at 2.2 percent after inflation picked up. The 10-year note had exceeded inflation by almost 60 basis points at the end of the fourth quarter 2011.

The Treasury held three note auctions totaling $99 billion this week. The $29 billion sale of seven-year notes on Oct. 25 drew of the least demand since May 2009, while concern the U.S. economic recovery is faltering drove record demand from a group of investors that includes pension funds and insurance companies at the government’s auction of $35 billion of two-year notes on Oct. 23.

Cash Totals

The note sales and a $7 billion auction of 30-year inflation-linked bonds on Oct. 18 raised $54.8 billion of fresh cash, as maturing securities held by the public totaled $51.2 billion, according to the U.S. Treasury.

Benchmark 10-year notes dropped after the Fed ended its policy meeting Oct. 24 without saying whether it will continue with Treasury purchases after the expiration of its so-called Operation Twist in December. Employment and growth are central themes in the campaigns of President Barack Obama and Republican challenger Mitt Romney.

The U.S. economy expanded at a faster-than-forecast 2 percent annual rate in the third quarter. Gross domestic product, the value of all goods and services produced in the U.S., rose after climbing 1.3 percent in the second quarter, Commerce Department figures showed yesterday in Washington. The median forecast of 86 economists surveyed by Bloomberg called for a 1.8 percent gain.

Economic Pace

“It’s a little bit better than expectations,” said Ira Jersey, an interest-rate strategist in New York at Credit Suisse Group AG, one of the 21 primary dealers that trade with the Fed. “Consumption was weaker than thought. It’s a mixed bag altogether.”

Structural headwinds, the budget deficit and the fiscal cliff will dominate the economic debate no matter who wins the presidential election, said Pacific Investment Management Co.’s Bill Gross.

“It means lower growth,” Gross, who runs the world’s biggest bond fund, said in an interview on Bloomberg Television’s “In the Loop” with Betty Liu. “The structural issues are really related to an excessive amount of debt, an excessive amount of leverage that’s been built up over 10 or 20 years.”

Spanish unemployment exceeded 25 percent in the third quarter as a deepening recession left one in four workers jobless, a government report showed yesterday, adding to concern the region’s debt crisis hasn’t been contained.

“There’s still a flight-to-quality bid being generated by concern for Europe,” said David Coard, head of fixed-income trading in New York at Williams Capital Group, a brokerage for institutional investors. “It’s a roller-coaster ride.”

The benchmark yield will drop to 1.73 percent by year-end, according to a Bloomberg survey of economists with the most recent projections given the heaviest weightings. The rate will rise to 2.33 percent by the close of 2013, the responses show.

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