Can’t Blame the Fed for Treasury Selloff Keyed by Rout in Europe

The last time Treasuries fell this much in a week, a blowout jobs report had traders speculating the Federal Reserve would raise interest rates in September. This time, traders’ expectations barely budged.

Instead, the worst week for Treasuries in two months was triggered by a broad exit of investors from some of the most popular bets of this year. It started with a dive in European sovereign debt, which dimmed the allure of relatively higher U.S. yields, and continued with drops by the U.S. dollar and global stocks, all of which have gained on the year.

“The bigger thing that’s been driving rates higher is what’s going on in Europe,” said Donald Ellenberger, a senior portfolio manager with Federated Investors. “If you look at the typical U.S. growth indicators, they’ve been soft.”

The 10-year U.S. Treasury note’s yield rose 20 basis points, or 0.20 percentage point, to 2.11 percent for the week, according to Bloomberg Bond Trader data. The benchmark 2 percent note due in February 2025 fell 1 26/32, or $18.13 per $1,000 face amount, to 99.

That was the worst performance by Treasuries since the first week of March, when the U.S. reported its lowest unemployment rate in almost seven years. That pushed down the price of contracts betting on September interest rates by 6.5 basis points in one day, the second biggest drop this year.

‘Nearly Impossible’

For this whole week, the price of those contracts fell by less than a third of that amount. That reflects the week’s mixed economic data, which left investors without much additional insight on Fed policy. Officials are waiting to determine whether the U.S. economy can withstand higher borrowing costs before raising rates.

A reading of first-quarter gross domestic product fell well below forecasts, while consumer confidence rose in April and initial jobless claims dropped last week.

“These past couple of weeks have been really difficult -- attaching these reports to any price action has been nearly impossible,” said Michael Lorizio, senior trader with Manulife Asset Management in Boston.

While Fed policy makers held rates steady this week and suggested first-quarter economic weakness may by transitory, Bank of America Merrill Lynch analysts attributed nearly all of the Treasuries drop this week to global factors.

The decline in European government debt happened in part because investors had piled into the debt before the European Central Bank started its widely anticipated bond-buying program. The U.S. dollar fell against the euro for a third week.

Lid Lifted

“People front-running easing in Europe acted as kind of a lid” on long-term Treasury yields, since low yields in Europe made U.S. debt more attractive, said Federated’s Ellenberger. “Once we saw some of those German yields start to move higher, that lifted the lid.”

German 10-year bund yields rose 22 basis points on the week to 0.37 percent, the biggest increase in two years.

Inflation in the U.S. has recently shown signs of recovery, as well, as oil prices stabilize after a sharp decline. Because longer-dated debt is hurt worst by rising prices, the difference between the yield on two-year Treasuries and 30-year Treasuries rose to its highest level since December.

“The market is building in modestly higher inflation expectations,” said Thomas Urano, a bond-portfolio manager with Sage Advisory Services Ltd. in Austin Texas, which manages $11 billion in assets. “Inflation could bottom out here or drift higher.”

Urano recently bought Treasury Inflation Protected Securities, which protect holders from rising prices.

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