Treasuries rallied, with 10-year note yields falling the most since July, as investors pared wagers for early interest-rate increases after the Federal Reserve unexpectedly refrained from reducing debt purchases.
Yields on the benchmark 10-year security posted the biggest one-day decline in almost two years on Sept. 18, after Fed Chairman Ben S. Bernanke said policy makers would await more evidence of sustained growth before tapering bond purchases being used to damp borrowing costs. The Treasury will sell $97 billion in two-, five- and seven-year notes next week.
“The market was completely caught off guard by Bernanke and the Fed,” said Jason Rogan, managing director of U.S. government trading in New York at Guggenheim Partners LLC, which oversees about $180 billion in assets. “It’s clear that Bernanke doesn’t think the economy is ready for the Fed to pull back, and that means stronger Treasuries.”
The 10-year yield fell 15 basis points, or 0.15 percentage point, to 2.76 percent this week in New York, according to Bloomberg Bond Trader prices. The yield dropped 16 basis points on Sept. 18, the biggest decline since Oct. 31, 2011. The weekly drop was the largest since the five days ended July 12. The 2.5 percent note due in August 2023 rose 1 9/32, or $12.81 per $1,000 face value, to 97 31/32.
Investors see a 43 percent chance that policy makers will increase the federal funds rate target to 0.5 percent or more by January 2015, based on data compiled by Bloomberg from futures contracts. The odds were 68 percent two weeks ago as traders began to factor in the probability that an end to the Fed’s quantitative-easing program would eventually be followed by an increase in the target rate for overnight loans between banks.
“Weaker data came in,” Federal Reserve Bank of St. Louis President James Bullard said yesterday on Bloomberg Television’s “Bloomberg Surveillance” with Tom Keene and Michael McKee. “That was a borderline decision,” and “the committee came down on the side of, ‘Let’s wait.’”
“Inflation is low,” Bullard said. “We can afford to be patient.”
Yields on 10-year notes, the benchmark rate on loans ranging from mortgages to corporate bonds, climbed as high as 3 percent Sept. 6 from 1.93 percent on May 21, the day before Bernanke said that the central bank could slow the pace of Treasury and mortgage bond purchases in the next few policy meetings.
Markets shouldn’t have been surprised by the decision because Federal Open Market Committee members have repeatedly said the decision to slow, or taper, would be “data dependent,” Bullard said.
“Everybody’s nerves are frayed,” said David Robin, an interest-rate strategist in New York at Newedge USA LLC, an institutional-brokerage firm. “The market is still trying to figure out what the yield-curve shape is supposed to look like and sort out positions” since the FOMC.
The extra yield on Treasury 30-year bonds over five-year notes widened to 238 basis points, the most since March, on Sept. 19 as the Fed’s decision boosted demand for shorter-maturity debt that is typically more sensitive to changes in central bank rate expectations.
“Conditions in the job market today are still far from what all of us would like to see,” Bernanke said at a Sept. 18 press conference in Washington after the central bank’s two-day meeting. “The committee has concern that rapid tightening of financial conditions in recent months would have the effect of slowing growth.”
The consumer-price index increased 0.1 percent in August, the least in three months, Labor Department figures showed Sept. 17. The median forecast in a Bloomberg survey of 87 economists called for a 0.2 percent gain. Consumer prices increased 1.5 percent in the 12 months ended in August after a 2 percent year-over-year gain the prior month.
The Treasury’s sale of $13 billion in 10-year inflation-indexed notes on Sept. 19 attracted the least demand since 2009 from a group of investors that includes pension funds and insurers, with U.S. consumer prices rising less than forecast.
Direct bidders, non-primary-dealer investors that place bids directly with the Treasury, bought 1.6 percent of the Treasury Inflation Protected Securities auctioned, the least since October 2009. The notes were sold at a yield of 0.5 percent, the highest since July 2011.
The federal funds rate target will be 2 percent at the end of 2016, according to the median of estimates by five governors on the Fed’s board and 12 reserve bank presidents. That rate compares with their median estimate of 4 percent for where the rate should be at a time of full employment and stable prices. The average rate over the past 20 years is 3.12 percent.
“The market made a big mistake,” said Jim Bianco, president of Bianco Research LLC in Chicago, said in a telephone interview. “Wall Street made the mistake of taking silence from the Fed as approval of tapering, when instead the silence was because of a lack of consensus among the policy makers there.”
The Treasury will sell $33 billion in two-year notes on Sept. 24, a drop of $1 billion from the sale of the securities last month, the department announced on Sept. 19. It will sell $35 billion in five-year securities the next day in what will be considered an additional issue of the outstanding seven-year notes issued Sept. 30, 2011. The U.S. will auction $29 billion in seven-year debt on Sept. 26.
Treasury trading volume at ICAP Plc, the largest inter-dealer broker of U.S. government debt, averaged $273 billion a day this week, after surging to $459.9 billion the day before. The 2013 average is $317.9 billion.