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Treasuries Rallies Most Since March on Downed Plane, Gaza Crisis

July 17 (Bloomberg) -- Treasury 10-year notes rallied the most since March as reports of a Malaysian plane being shot down in eastern Ukraine and Israel’s military starting ground operations in the Gaza strip boosted refuge demand.

Thirty-year bond yields fell to the lowest level in more than a year after a Malaysian Boeing 777 with 295 aboard crashed near the Russian-Ukraine border added to to haven appeal linked to expanded sanctions against Russia for support of separatist rebels. The difference between five- and 30-year yields narrowed to the least since 2009 a day after Federal Reserve Chair Janet Yellen told lawmakers monetary stimulus is still needed, while increases in interest rates may occur sooner if the economy accelerates.

“That’s why they are coming into the U.S. Treasury market right now,” said Michael Franzese, senior vice president of fixed-income trading at ED&F Man Capital Markets in New York. “There are too many geopolitical risks. You have the Middle East problem with Israel going into Gaza. With all the uncertainty, why take a risk?”

The 10-year yield dropped eight basis points, or 0.08 percentage point, to 2.45 percent at 4:59 p.m. New York time, according to Bloomberg Bond Trader Prices. The 2.5 percent notes maturing in May 2024 added 22/32, or $6.88 percent $1,000 face amount, to 100 15/32. The yield fell as much as nine basis points, the most since March 13.

U.S. 30-year yield fell seven basis points to 3.27 percent, touching the lowest level since June 2013.

Ukraine Situation

The amount of Treasuries traded through Icap Plc, the largest inter-dealer broker of U.S. government debt, rose to $363 billion, from $221 billion yesterday. The daily average volume this year is $330 billion.

The flight from Amsterdam to Kuala Lumpur was hit by a missile and went down near the eastern town of Torez, about 30 kilometers (18 miles) from the Russian border, Ukrainian Interior Minister adviser Anton Gerashchenko said on his Facebook page. Rebels in the self-proclaimed Donetsk People’s Republic said they weren’t involved, Interfax news service reported, citing Sergey Kavtaradze, a security official with the group.

Israel’s movement of troops and tanks into the Hamas-controlled coastal enclave marks the first significant Israeli ground operation in Gaza since 2009. It follows intensified aerial attacks in which more than 200 Gaza residents were killed. Palestinians launched some 1,250 rockets into Israel, killing one, with many intercepted by Israeli missile defenses.

“The prime minister and defense minister have instructed the Israel Defense Forces to begin a ground operation tonight to destroy the terror tunnels dug from the Gaza Strip into Israeli territory,” Prime Minister Benjamin Netanyahu’s office said in a text message.

Swap Spreads

The spread between the rate to exchange floating for fixed interest payments and Treasury yields for two years reached its widest in eleven months as tensions over the Ukraine increased perceived risk in the financial markets.

The difference between the two-year swap rate and the similar maturity Treasury note yield, known as the swap spread, widened to as much as 20.38 basis points from 18 basis points yesterday. The spread touched today the widest since Aug. 23, 2013. It reached a low this year of 8.94 basis points on April 23. The measure is a gauge of investor perceptions of credit risk and is based on expectations for the London interbank offered rate, or Libor.

The Treasury announced it will sell $15 billion in 10-year inflation-indexed debt on July 24. It previously sold $13 billion of the securities on May 22 at a yield of 0.339 percent.

Yield Difference

The gap between five-year notes and 30-year bonds, known as the yield curve, shrank as low as 163 basis points, the least since February 2009. A yield curve is a chart showing rates on bonds of different maturities.

“The front end is most vulnerable because of Fed expectations,” said Thomas Tucci, managing director and head of Treasury trading in New York at CIBC World Markets Corp. “The front end will continue to underperform.”

Thirty-year securities rose 2.4 percent in the two weeks ended yesterday, for a gain of 13.7 percent in 2014, based on Bank of America Merrill Lynch indexes. The whole market returned 0.4 percent over two weeks and 3 percent this year. Shorter maturities are more sensitive to what the Fed does with its benchmark rate, while longer-dated debt is more influenced by inflation.

A Labor Department report showed jobless claims declined by 3,000 to 302,000 in the week ended July 12.

Economic Outlook

Housing starts fell 9.3 percent to an 893,000 annualized rate from a 985,000 pace in May that was weaker than initially estimated, figures from the Commerce Department showed. The median estimate of 79 economists surveyed by Bloomberg called for a 1.02 million rate.

“The big debate in the market is the pace of the economy and the housing component is a big part of that,” said Adrian Miller, director of fixed-income strategies at GMP Securities LLC in New York.

Investors see a 75 percent chance the Fed will raise its key rate by September 2015, futures contracts show. The central bank has kept its target for the benchmark, the rate banks charge each other on overnight loans, in a range of zero to 0.25 percent since December 2008.

Treasuries rose earlier as the U.S. and the European Union imposed the most aggressive sanctions to date on Russian businesses and said more may follow, acting after weeks of threats to squeeze the $2 trillion economy due to the confrontation in Ukraine.

The sanctions will prevent the Russian companies from accessing U.S. equity or debt markets for new financing with a maturity beyond 90 days. That will raise borrowing costs and effectively cut off medium- and long-term U.S. financing.

“They’ve been buying longer-dated paper on the flight-to-quality,” CIBC’s Tucci said. “The Russian situation triggered short-covering.” Short positions are bets that an asset will decline in value.

To contact the reporter on this story: Susanne Walker in New York at swalker33@bloomberg.net

To contact the editors responsible for this story: Dave Liedtka at dliedtka@bloomberg.net Paul Cox, Greg Storey

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