Treasuries Gain as Fed Officials Say Outlook Drew Overreaction

Treasuries rose for a second day as Federal Reserve officials said investors may have overreacted to prospects for a reduction in the central bank’s bond-buying program as a selloff pushed yields to the highest since 2011.

Ten-year note yields fell to the lowest in almost a week as New York Fed Bank President William C. Dudley said policy makers may prolong asset purchases and Atlanta Fed President Dennis Lockhart sought to damp bets an interest-rate boost will come sooner than forecast. The U.S. sold $29 billion of seven-year notes, with indirect bidders, an investor class that includes foreign banks, buying the biggest share in almost two years.

“It seems like the Fed did not intend for the market to react the way it did about their plans for tapering,” said David Coard, head of fixed-income trading in New York at Williams Capital Group LP, a brokerage for institutional investors. “You have yields flirting with two-year highs.”

The 10-year yield slid six basis points, or 0.06 percentage point, to 2.47 percent at 4:59 p.m. in New York, according to Bloomberg Bond Trader prices. It reached 2.46 percent, the lowest since June 21. The 1.75 percent security due in May 2023 climbed 17/32, or $5.31 per $1,000 face amount, to 93 22/32.

The benchmark yield dropped seven basis points yesterday, the biggest decline since June 13. It touched 2.66 percent on June 24, the highest since August 2011.

The current seven-year note yield sank seven basis points to 1.89 percent. It touched 2.11 percent on June 24, the highest level since August 2011. Thirty-year bond yields decreased five basis points to 3.53 percent. They reached 3.65 percent on June 24, the highest intraday level since September 2011.

Volume Declines

Treasury trading volume at ICAP Plc, the largest inter-dealer broker of U.S. government debt, fell 9 percent to $419 billion. The 2013 average is $322 billion.

Volatility in Treasuries declined to 103.46 on June 26, the most recent data available, as measured by Bank of America Merrill Lynch’s MOVE index. It climbed to 110.98 on June 24, the highest since November 2011. It has averaged 62.25 this year.

Treasuries lost 1.8 percent this month through yesterday, according to the Bloomberg U.S. Treasury Bond Index. The MSCI World Index of shares declined 3 percent in the same period, including reinvested dividends. Treasuries have fallen 2.6 percent this quarter and 2.8 percent this year, according to the Bank of America Merrill Lynch U.S. Treasury Index.

Bernanke Comments

Ten-year note yields rose by 40 basis points last week, the most since the start of the Iraq war in 2003, as Fed Chairman Ben S. Bernanke said June 19 the central bank may reduce bond purchases this year and end them entirely in 2014 if economic growth is in line with central bank projections. Policy makers forecast growth of as much as 2.6 percent this year and 3.5 percent in 2014.

The central bank is buying $85 billion of Treasuries and mortgage bonds every month to put downward pressure on borrowing costs during the third round of its quantitative-easing stimulus program. It has kept its key interest-rate target at zero to 0.25 percent since 2008 to support the economy.

Lockhart, using an analogy to a cigarette smoker trying to quit, said “it seems to me the chairman said we’ll use the patch and use it flexibly, and some in the markets reacted as if he said ‘cold turkey.’” Lockhart spoke at a Kiwanis Club in Marietta, Georgia.

‘Way Off’

Dudley said any decision to reduce the pace of asset purchases wouldn’t represent a withdrawal of stimulus, and that an increase in the Fed’s benchmark interest rate is “very likely to be a long way off.” The economy may also diverge from the Fed’s forecasts, he told reporters in New York.

“The Fed is trying to steer the market a little bit away from thinking rates are going to go up” soon, said Ray Remy, head of fixed income in New York at Daiwa Capital Markets America Inc. “They are on hold for a long period.”

Fed Governor Jerome Powell said in Washington any decision to reduce bond buying would depend on economic data, and that there’s no set timetable.

The seven-year notes sold today drew a yield of 1.932 percent, compared with a forecast of 1.942 percent in a Bloomberg News survey of six of the Federal Reserve’s 21 primary dealers. The bid-to-cover ratio, which gauges demand by comparing total bids with the amount of securities offered, was 2.61, versus an average of 2.67 for the past 10 sales.

Bidder Participation

Indirect bidders, an investor class that includes foreign central banks, purchased 46.4 percent of the notes, the most since August 2011, compared with an average of 37.8 percent for the past 10 sales.

Direct bidders, non-primary-dealer investors that place their bids directly with the Treasury, bought 15.7 percent of the notes, the least since July 2012. The average at the past 10 auctions was 19.4 percent.

Today’s offering is the final of three note auctions this week totaling $99 billion. The government sold $35 billion in two-year debt on June 25 and another $35 billion in five-year debt yesterday.

Investors have bid $2.94 for each $1 of the $1.077 trillion of notes and bonds sold by the Treasury in the first half of 2013, compared with a record high $3.15 for all of last year.

Bonds pared gains earlier after the National Association of Realtors’ index of pending U.S. home sales jumped 6.7 percent to 112.3, the highest since December 2006.

Treasuries had stayed higher after U.S. consumer spending increased 0.3 percent in May after a 0.3 percent decline the prior month, the Commerce Department reported.

Data yesterday showed U.S. gross domestic product expanded at a revised 1.8 percent annualized rate in the first quarter, down from a prior estimate of 2.4 percent.

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