Treasuries Fall as Stronger European Economic Conditions

Treasuries fell as stocks in Europe rebounded from the biggest decline in three months and the gap narrowed between German government debt yields and those in Spain and Italy.

Benchmark 10-year yields traded close to the highest since April after euro-area data showed services and manufacturing output was revised higher last month, based on a survey of purchasing managers. German bund yields rose as a rally in equities curbed demand for safe assets, while Spanish and Italian yields fell on easing political concern. The U.S. government will post its first sub-$1 trillion federal deficit in five years, according to the Congressional Budget Office.

“It is risk-on,” said Sean Simko, who oversees $8 billion at SEI Investments Co. in Oaks, Pennsylvania. “The question that has to be asked ’is the move in the Treasury market sustainable?’ The world’s improving, but there are still consistent themes that probably warrant the Treasury market to remain in a range.”

The benchmark 10-year yield climbed four basis points, or 0.04 percentage point, to 2 percent at 5 p.m. New York time, according to Bloomberg Bond Trader prices. The yield straddled 2 percent for the fifth day and touched 2.06 percent yesterday, the most since April 12, before closing lower. The 1.625 percent note maturing in November 2022 fell 12/32, or $3.75 per $1,000 face amount, to 96 22/32.

Price Swings

Treasury volatility, as measured by the Bank of America Merrill Lynch MOVE index dropped yesterday for a third day to 63.1, from a 12-week high of 66.4 on Jan. 30. The index has averaged 56.7 since Nov. 7, the day after President Barack Obama’s re-election.

A measure of traders’ inflation expectations that the Fed uses to help determine monetary policy rose to the most since August 2011. The five-year, five-year forward break-even rate reached 2.93 percent. The tool projects what the pace of price increases may be starting in 2018.

The Federal Reserve bought $1.5 billion of Treasuries maturing from February 2036 to November 2042 as part of its plan to bolster the economy. The central bank is buying $85 billion a month of Treasuries and mortgage-backed securities.

The U.S. government will post an $845 billion deficit this fiscal year, the first time in five years that the shortfall has been below $1 trillion, though the long-term budget outlook remains grim, the CBO said today in Washington.

Budget Analysis

In the first comprehensive analysis of the government’s finances since last month’s fiscal-cliff deal, the nonpartisan agency said a surge of tax revenue will help cut the deficit to its lowest since 2008. Next year’s shortfall will total $616 billion, and the government is projected to rack up at least $7 trillion in deficits over the next decade, according to the CBO.

“The markets are hinged on how we get through the sequester process,” said Scott Graham, head of government-bond trading at Bank of Montreal’s BMO Capital Markets unit in Chicago, one of the 21 primary dealers that trade with the Fed. “We’re only one month into the year, and the potential impact from the tax increases have yet to be felt. I am expecting a slow-down in some of the economic data.”

The Institute for Supply Management’s U.S. non-manufacturing fell to 55.2 in January after climbing to a 10-month high of 55.7 in December. The median forecast of 76 economists in a Bloomberg News survey was 55. A reading above 50 indicates expansion.

“The U.S. economy is putting in some decent data,” said Thomas di Galoma, a managing director at Navigate Advisors, a brokerage for institutional investors in Stamford, Connecticut. “The fundamentals seem to be getting better in the economy. The 24-hour safe-haven bid seems to be evaporating.”

European Yields

Yields on German 10-year bunds gained four basis points, to 1.65 percent. The yield on Spanish government debt maturing in 10 years fell six basis points to 5.35 percent, while the yield on Italian 10-year securities dropped one basis point to 4.45 percent.

Spain’s Prime Minister Mariano Rajoy battled to rebut corruption allegations, which sent yields surging yesterday. Opposition leader Alfredo Perez Rubalcaba demanded on Jan. 3 that Rajoy step down to restore faith in the nation’s political class.

Italy’s caretaker Prime Minister Mario Monti accused former Prime Minister Silvio Berlusconi of trying to buy votes by promising a cash rebate of 4 billion euros. Concern about the potential for a Berlusconi comeback had contributed to a rise in Italian yields yesterday.

European services and manufacturing output shrank less than initially estimated in January, adding to signs the currency bloc’s economy is beginning to emerge from recession.

A composite index rose to 48.6 from 47.8 in December, London-based Markit Economics said in a report today. That’s above an initial estimate of 47.2 published on Jan. 24. A reading below 50 indicates contraction.

Treasuries have handed investors a 0.9 percent loss this year as of yesterday, according to Bank of America Merrill Lynch indexes, as money managers sought higher-yielding assets.

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