Treasury Yields Drop Most in Three Weeks Amid Concern on Europe

Treasuries rose, pushing 10-year note yields down the most in three weeks, as an unprecedented proposed levy on bank deposits in Cyprus threatened to reignite the euro region’s debt crisis, boosting demand for a refuge.

The 10-year yields traded below 2 percent for a second day before the Federal Reserve begins a meeting tomorrow amid speculation policy makers will decide the central bank should keep buying bonds to spur economic growth. Euro-area finance ministers sought to tax bank deposits in Cyprus as part of a plan for a 10 billion-euro ($13 billion) bailout of the nation.

“The Cyprus news was the biggest and most negative news we’ve had in some time,” said Guy LeBas, chief fixed-income strategist at Janney Montgomery Scott LLC in Philadelphia, which oversees $12 billion in fixed income assets. “Still, the market is waiting for more news out of Europe, now that we know the risks, to drive us one way or the other.”

The U.S. 10-year yield fell four basis points, or 0.04 percentage point, to 1.96 percent at 5 p.m. in New York, according to Bloomberg Bond Trader prices. It dropped as much as nine basis points, the biggest intraday slide since Feb. 25. The price of the 2 percent note due in February 2023 increased 10/32, or $3.13 per $1,000 face amount, to 100 13/32.

The benchmark yield had closed above 2 percent for five straight trading days ended March 14. It has traded in a 25 basis-point range since the end of January, falling to as low as 1.83 percent on March 4 and rising to 2.08 percent on March 8.

Thirty-year bond yields sank as much as 10 basis points today before trading at 3.18 percent, down three basis points.

‘Receded Some’

Treasuries pared gains as European policy makers signaled flexibility on the application of the bank tax. While they demanded that the levy raise the targeted 5.8 billion euros, finance officials said easing the cost to smaller savers was up to Cyprus. A vote on the tax by Cyprus’s Parliament was delayed for a second day until tomorrow.

“The concern from Cyprus has receded some, but there is still the question if something like this could spread,” 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. “You have to continue to play the range, and sell into strength. We are still in a generally bearish environment.”

Treasuries lost 0.9 percent this year as of March 15, poised for the biggest quarterly decline since the first three months of 2012, Bank of America Merrill Lynch indexes show. The Standard & Poor’s 500 Index of U.S. shares returned 10 percent, including reinvested dividends.

Cost Levels

The 10-year term premium, a model that includes expectations for interest rates, growth and inflation, was negative 0.67 percent today, the most expensive level since March 6. A negative reading indicates investors are willing to accept yields below what’s considered fair value

Scenes of Cypriots lining up at cash machines raised the specter of capital flight elsewhere and threatened to disrupt a market calm since the European Central Bank’s pledge in September to backstop troubled nations’ debt. The region’s fiscal crisis began in 2009 in Greece.

“We may have seen a bit of an overreaction, but people don’t know where the chips lie, if there could be a domino effect in the market and what impact it will have on the global market, and so Treasuries have remained well bid,” Paul Horrmann, a broker in New York at the interdealer broker Tradition Asiel Securities Inc., said.

Fed Meeting

The Fed bought $1.46 billion of Treasuries today due from February 2036 to February 2043 as part of its efforts to stimulate the economy through lower borrowing costs. It purchases $85 billion a month in Treasury and mortgage debt. Policy makers reiterated at their January meeting that they’ll keep buying bonds until there’s substantial improvement in the labor market.

The central bank opens a two-day policy meeting tomorrow. It will issue a statement and economic projections at about 2 p.m. New York time on March 20, and Chairman Ben S. Bernanke will brief reporters at about 2:30 p.m. The previous schedule was revised to “facilitate the release of information” in conjunction with the briefing, the Fed said.

Treasuries have lost 0.5 percent this month, according to Bank of America Merrill Lynch data, amid optimism the recovery in the world’s largest economy is gaining traction. Data this month showed the U.S. unemployment rate dropped to 7.7 percent, the lowest level since December 2008, and retail sales rose.

Inflation Bets

Traders’ inflation expectations shrank today to the least in almost two weeks. The yield gap between 10-year notes and Treasury Inflation Protected Securities, called the 10-year break-even rate, touched 2.56 percentage points, the narrowest since March 5. The gap, which swelled to a three-week high of 2.6 percentage points on March 8, signals traders’ outlook for consumer prices over the life of the debt. It averaged 2.35 over the past year.

Hedge funds are the most bullish on 10-year Treasuries since 2007, betting the U.S. economy is too fragile for the Fed to stop buying bonds even as the jobless rate declines and household wealth increases.

Investors using borrowed funds to boost returns, so-called leveraged accounts, held $56.2 billion in contracts wagering on gains in 10-year Treasury futures in the week ending March 5, data from the Commodity Futures Trading Commission show. That’s the most since just before credit markets froze and the economy went into recession, sparking a rally in government bonds. As recently as July, there were net bets against the Treasuries.

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