Treasuries Gain After U.S. Manufacturing Unexpectedly Contracts

Treasuries rose, pushing 10-year yields down from almost a 14-month high, as an unexpected drop in U.S. manufacturing in May damped bets the Federal Reserve will slow bond purchases under its quantitative-easing stimulus.

Bonds fell earlier after Fed Bank of San Francisco President John Williams said the central bank’s asset buying may end this year. Ten-year yields climbed last month by the most since December 2010 on bets the Fed would scale the program back. The Institute for Supply Management’s factory index showed manufacturing shrank at the fastest rate since June 2009.

“This is a sign of contraction instead of expansion,” Michael Franzese, senior vice president of fixed-income trading at ED&F Man Capital Markets in New York, said in a telephone interview. “We just broke out.”

Benchmark 10-year note yields declined two basis points, or 0.02 percentage point, to 2.119 percent at 12:55 p.m. New York time, according to Bloomberg Bond Trader data. They increased earlier to 2.19 percent. The yields climbed on May 29 to 2.23 percent, the highest since April 2012. The price of the 1.75 percent security due in May 2023 gained 6/32, or $1.88 per $1,000 face amount, to 96 26/32.

The yield on 30-year bonds decreased two basis points to 3.26 percent after rising earlier to 3.33 percent.

The ISM’s factory index fell to a reading of 49, from the prior month’s 50.7, the Tempe, Arizona-based group’s report showed today. Fifty is the dividing line between growth and contraction. The median forecast of 81 economists surveyed by Bloomberg was for an advance to 51.

Surprise Number

“Guys got caught by surprise on the manufacturing number,” said Thomas Tucci, managing director and head of Treasury trading in New York at CIBC World Markets Corp. “There’s a better bid in the market.”

Yields rose earlier after the Fed’s Williams, who doesn’t vote on monetary policy this year, told reporters in Stockholm the U.S. central bank may start reducing its bond buying by “this summer” and potentially conclude it by year-end. Williams was one of the first Fed officials to advocate that the Fed buy bonds without setting a limit on the duration or total for such purchases.

“Williams’s comments created a stir because he was seen by some as a dove,” said David Keeble, head of fixed-income strategy at Credit Agricole Corporate & Investment Bank in New York.

The Fed is buying $85 billion of Treasury and mortgage debt a month to support the economy by putting downward pressure on interest rates. The central bank purchased $1.46 billion today of Treasuries due between February 2036 and February 2043.

Timing Debate

Ten-year yields climbed in May by 46 basis points, the most since December 2010, amid debate on the Fed’s timing in curtailing the monetary stimulus amid stronger-than-forecast economic data.

A Labor Department report on May 3 showed the unemployment rate unexpectedly fell in April to a four-year low of 7.5 percent and U.S. employers added 165,000 jobs, more than projected. Nonfarm payrolls increased by 168,000 jobs in May, economists forecast before a June 7 Labor Department report.

Sales of new and previously owned homes rose in April and consumer confidence climbed, other data showed.

At the same time, a gauge tracked by the Fed known as the personal consumption expenditure deflator fell by 0.3 percent in April, the biggest drop since December 2008, a government report said May 31.

Inflation Outlook

The gap between 10-year Treasury yields and similar maturity Treasury Inflation Protected Securities, an indicator of traders’ inflation outlook known as the 10-year break-even rate, was 2.19 percentage points today after narrowing to 2.15 percentage points on May 30, the lowest level since July 2012. The average this year is 2.45 percent.

May’s bond rout has still left global yields short of the tipping point that would signal a bear market.

Yields on U.S. Treasuries, German bunds and Japanese government bonds are about one standard deviation above their historical norm. Treasury 10-year rates have reached two standard deviations above the average twice since 2009, and each time the notes rallied.

While sovereign yields at 1.39 percent are above the record low of 1.14 percent set May 2, they are about half the 3.64 percent average of the past 20 years, based on Bank of America Merrill Lynch’s Global Government Index.

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