Treasury Yield Curve Steepens as Fed Spurs Inflation Bets
The yield gap between 10- and 30- year Treasuries widened to the most in a year on concern the Federal Reserve’s plan to buy more debt on an open-ended basis and its pledge to keep monetary policy accommodative even when the economy strengthens will spur inflation.
The difference touched 1.21 percentage points, the most since August 2011, as yields on 30-year debt, more sensitive to inflation because of its longer maturity, climbed to the highest since May. Long bonds pared losses after Fed Chairman Ben S. Bernanke said the central bank retains the capacity to purchase U.S. government debt after it refrained from including the securities in the plan to buy assets. The Fed also said it would probably keep interest rates at virtually zero into 2015.
“Leaving their purchases open-ended and extending their guidance means a steeper yield curve, as there is more inflation risk,” said Sean Murphy, a trader at Societe Generale in New York, one of the 21 primary dealers that trade with the central bank. “The need to come out with the operation at all is alerting everyone that there is a long road in this recovery and there are still many things that need to be addressed.”
Thirty-year bond yields rose as much as eight basis points, or 0.08 percentage point, to 3 percent, the highest level since May 14, before closing at 2.93 percent at 5 p.m. in New York.
Yields on 10-year notes fell four basis points to 1.72 percent after advancing earlier to 1.83 percent, the highest since Aug. 21. They slid to a record 1.379 percent on July 25 and climbed to a three-month high of 1.86 percent on Aug. 21.
Other assets rallied after the Fed’s statement, with the Standard & Poor’s 500 Index climbing 1.6 percent and gold futures gaining as much as 2.4 percent to $1,775 an ounce.
The difference in yield between 10-year notes and similar- maturity Treasury Inflation Protected Securities, a gauge of traders’ outlook for consumer prices known as the break-even rate, reached 2.49 percentage points, the most since July 2011. It has averaged 2.2 percent this year.
FOMC officials upgraded their estimate for 2013 gross domestic product growth to 2.5 percent to 3 percent, compared with 2.2 percent to 2.8 percent in June. Estimates for 2014 are from 3 percent to 3.8 percent, versus 3 percent to 3.5 percent in the previous forecast.
Almost two-thirds of economists in a Bloomberg survey had forecast the central bank would announce more government debt purchases under quantitative easing. The Fed bought $2.3 trillion of Treasuries and mortgage-related debt in two rounds of the stimulus strategy from 2008 to 2011.
“If the outlook for the labor market does not improve substantially, the committee will continue its purchases of agency mortgage-backed securities, undertake additional asset purchases and employ its other policy tools as appropriate,” the FOMC said today in a statement at the end of a two-day meeting in Washington.
The Fed will make open-ended purchases of $40 billion of mortgage debt a month as it seeks to boost economic growth and reduce employment, the committee said.
“A highly accommodative stance of monetary policy will remain appropriate for a considerable time after the economic recovery strengthens,” the FOMC said.
Yields on Fannie Mae-guaranteed mortgage bonds trading closest to face value declined 18 basis points to 2.18 percent as of 3:05 p.m. in New York, according to data compiled by Bloomberg. The gap with an average of five- and 10-year Treasury rates narrowed 16 basis points to about 98 basis points, the lowest since 1992.
In adding accommodation less than two months before the Nov. 6 presidential election, Bernanke and the Fed drew a contrast between the engagement of monetary officials and the inability of fiscal policy makers to take steps to boost the economy, said David Ader, head of U.S. government-bond strategy at CRT Capital Group LLC in Stamford, Connecticut.
“Part of this could be an assertion of the Fed’s independence,” Ader said.
Fiscal measures to support the economy during the crisis have been confined to the $787 billion stimulus passed in 2009 and the payroll-tax reduction combined with an extension of the Bush-era tax cuts approved after the 2010 elections.
“Bernanke and monetary policy can only do so much,” said Richard Schlanger, who helps invest $20 billion in fixed-income securities as vice president at Pioneer Investments in Boston. “I think Congress, the burden is really on them.”
The Fed’s approach may have been “on the light side” of expectations, said John Fath, a money manager at the investment firm BTG Pactual in New York who helps manage $2.5 billion in bonds. “If you look at when they did QE1 and QE2, inflation was at a lower level. Maybe it was more difficult with the hawks to overcome their opinions.”
Investors should buy seven-year Treasuries because the monthly purchases outlined by the Fed reflect a “fairly measured, although open-ended” approach that may last longer than earlier efforts, favoring intermediate maturities, Brett Rose, an interest-rate strategist in New York at the primary dealer Citigroup Inc., wrote in a note to clients.
Treasury 30-year bond yields reached their lowest level of the day, 2.86 percent, after the U.S. sold $13 billion of the securities before the Fed statement. The sale yielded 2.896 percent, compared with a forecast of 2.929 percent in a Bloomberg News survey of six primary dealers. The bid-to-cover ratio, which gauges demand by comparing total bids with the amount of securities offered, was 2.68, versus an average of 2.62 at the past 10 sales.
“If you went into the auction on a speculative long position, you got burned,” said Scott Sherman, an interest-rate strategist at the primary dealer Credit Suisse Group AG in New York. “The people who would fall into that category were the people who didn’t think the Fed was going to ease further. But they weren’t paying attention.” A long position is a bet a security will rise.
The central bank’s stimulus efforts since 2008 have failed to breathe life into the labor market, which Bernanke said last month is a “grave concern.” Unemployment has been stuck above 8 percent for 43 straight months. U.S. gross domestic product was 1.7 percent in the second quarter, after reaching 4.1 percent from October through December, the highest since 2006, Commerce Department data show.
“With the economy not running off to the races and inflation low, the policy accommodation helps everyone,” said Roger Bayston, senior vice president and director of fixed income at the Franklin Templeton fixed-income group, which has more than $350 billion in fixed-income assets under management. “They have room to do this because we are nowhere near maximum employment.”
The Fed also said today it will continue its Operation Twist program to replace shorter-term debt in its portfolio with longer-term securities to extend its holdings’ average maturity and put downward pressure on long-term borrowing costs.
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