Treasuries Erase Gain as Stock Rebound Damps Demand for Havens

  • Treasury will sell $48 billion of two- and five-year notes
  • Butterfly spread between 2-5-30 securities lowest in 18 months

Treasuries erased earlier advances after a rebound in stocks reduced demand for haven assets and before the U.S. government sells two- and five-year debt later on Wednesday.

The securities struggled to extend Tuesday’s gain as Pacific Investment Management Co. warned that investors should brace for “inflation getting back to the Fed’s 2 percent target over the next four quarters.” Treasuries had climbed earlier after a report showing Chinese manufacturing gauge fell to the lowest level in six years. The Stoxx Europe 600 Index of shares rose 0.6 percent after falling earlier. Five-year notes have outperformed their longer-dated peers this month, suggesting some investors remained unconvinced that the Federal Reserve will raise interest rates this year.

“It seems stocks and sentiments are the key drivers at the moment,” said John Stopford, head of fixed income at Investec Asset Management in London. “Treasury yields have come a long way, and a market view that the Fed will at one point have to raise interest rates, albeit at a gradual pace, will limit the scope of a decline in yields. I still think a December liftoff is possible.”

The U.S. 10-year yield rose two basis points, or 0.02 percentage point, to 2.15 percent as of 7:08 a.m. in New York, having fallen as much as three basis points earlier. The 2 percent note due August 2025 fell 5/32, or $1.56 per $1,000 face value, to 98 21/32.

The Treasury will sell $13 billion of two-year floating-rate notes and $35 billion of five-year securities. Two-year notes advanced on Tuesday after the government sold $26 billion of the securities at a yield of 0.699 percent, the highest at an auction since December. The five-year note due to be auctioned Wednesday yielded 1.48 percent in pre-auction trading.

Butterfly Spreads

Five-year Treasury notes are at their most expensive level in 18 months relative to two- and 30-year securities as traders scaled back their expectation for a rate increase by the Fed in December.

The so-called butterfly spread measuring differences between the yields was as low as minus 79 basis points on Wednesday, the least since March 2014. Two-year Treasuries are more sensitive to the outlook for monetary policy, while longer-term debt tends to react more to perceptions about inflation and the economy.

5-Year Outperformance

“People tend to buy five-year Treasuries when they are bullish about the bond market,” said David Schnautz, a London-based interest rates strategist at Commerzbank AG. “While we think the Fed is more likely than not to raise interest rates in December, the fact that the five-year is outperforming reflects the market’s increasing doubt about a liftoff this year or even early next year.”

Traders are pricing in a 43 percent probability of the U.S. central bank raising the benchmark rate by its December meeting, compared with 64 percent before the Fed’s latest policy decision on Sept. 17. That’s based on the assumption that the effective fed funds rate will average 0.375 percent after the first increase.

Treasuries have returned 0.5 percent in September, based on Bloomberg bond indexes, rebounding from an August loss after the Federal Reserve opted against raising interest rates at a meeting last week. Policy makers said they’re watching the global economy while debating when to end their six-year run of record-low borrowing costs.

Trading of Treasuries began at 7 a.m. in London after they were shut in Japan due to a holiday.

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