Treasuries Drop Most in 2 Years as Jobs Growth Supports Tapering

Treasury 10-year notes tumbled the most in almost two years after stronger-than-forecast employment growth stoked speculation the Federal Reserve will begin to reduce the size of its asset purchases.

Yields climbed to the highest levels since August 2011 as a Labor Department report showed the economy added 195,000 jobs in June, compared with the median forecast of 165,000 in a Bloomberg News survey. Fed Chairman Ben S. Bernanke said last month policy makers may “moderate” their bond-buying program this year and may end it mid-2014 if growth meets forecasts. The rate to exchange floating for fixed-rate payments for 30 years rose above the yield on similar maturity Treasury bonds for the first time since August 2009.

“Everybody is in the camp that the Fed is going to do something -- the question is when,” said Michael Franzese, senior vice president of fixed-income trading at ED&F Man Capital Markets in New York.

The 10-year note yield increased 24 basis points, or 0.24 percentage point, to 2.74 percent at 5 p.m. in New York, according to Bloomberg Bond Trader prices, the highest yield and biggest climb since August 2011. The 1.75 percent note maturing in May 2023 fell 1 30/32, or $19.38 per $1,000 face value, to 91 1/2.

The yield on the 30-year bond rose 22 basis points to 3.7 percent, the highest level since August 2011.

The U.S. bond market was closed yesterday for a public holiday.

Swap Spread

Volatility in Treasuries as measured by the Merrill Lynch Option Volatility Estimate MOVE Index closed at 117.89, the highest level since December 2010. The one-year average is 63.6.

Treasury trading volume at ICAP Plc, the largest inter-dealer broker of U.S. government debt, rose to $411.8 billion from $241.4 billion on July 3 when the U.S. market closed at 2 p.m. New York time. The 2013 average is $322.5 billion.

The 30-year swap spread moved above zero in a continuation of the rise that has taken place over the past year as Dodd-Frank Act regulations increased costs for swap transactions and made Treasury securities an attractive alternative.

The spread was 2.75 basis points, after being as much as negative 12 basis points on June 19.

Worst Performance

Treasuries in May and June lost 3.2 percent, their worst two-month performance since the first two months of 2009 when they lost 3.6 percent, Bank of America Merrill Lynch indexes show. U.S. government securities declined 2.5 percent in the first half of the year, their worst start since 2009 when they dropped 4.5 percent, the indexes show.

An improving economy is dimming the lure of bonds as a haven. The Conference Board’s Consumer Confidence index rose in June to 81.4, exceeding all forecasts in a Bloomberg survey and the highest since January 2008, the New York-based private research group said June 25. Home prices have increased 12 percent since April 2012, according to the S&P/Case-Shiller Composite index.

“It is a strong report that does keep the Fed on the taper trail,” Tony Crescenzi, executive vice president at Newport Beach, California-based Pacific Investment Management Co., said of the employment data in a radio interview on “Bloomberg Surveillance” with Tom Keene.

Economists at Goldman Sachs Group Inc. and JPMorgan Chase & Co. said the Federal Open Market Committee will begin tapering sooner than they had expected after today’s Labor Department report.

Quantitative Easing

“The labor market has continued to improve,” Bernanke said at his June 19 press conference. “Job gains, along with the strengthening housing market, have in turn contributed to increases in consumer confidence and supported household spending.”

The unemployment rate for June remained at 7.6 percent compared with the Bloomberg News survey of economists forecast of 7.5 percent. The economy has added an average of 189,000 jobs this year through May, the fastest pace since 2005 when it created 207,000 positions per month, Labor Department data show.

The central bank has been buying $85 billion in bonds monthly, a policy known as quantitative easing, to cap borrowing costs and stimulate the economy. It has kept its target rate at the zero to 0.25 percent level since December 2008.

“Expectations for a September taper are being completely priced in,” Shyam Rajan, an interest-rate strategist at Bank of America Merrill Lynch in New York, one of the 21 primary dealers that trade with the Fed. “The market’s expecting a smaller balance sheet going forward.”

Demand Falls

The Fed on July 10 will release minutes of its June 18-19 policy makers’ meeting.

European Central Bank President Mario Draghi pledged yesterday to keep interest rates at a record low for an “extended period.”

U.S. gross domestic product expanded at a revised 1.8 percent annualized rate from January through March, down from a prior estimate of 2.4 percent, the Commerce Department said June 26. The economy will grow 1.9 percent for 2013, according to the median forecast of 86 economists in a Bloomberg News survey in June, down from last year’s 2.2 percent increase.

A measure of demand at the U.S. Treasury Department’s debt auctions has fallen this year to the lowest level since 2009 as a drop in bond prices generates the biggest losses on government securities in four years.

Investors bid $2.94 for each $1 of the $1.077 billion of notes and bonds sold by the Treasury this year, compared with a record high $3.15 of bids last year. It’s the first decline in demand at the auctions since 2008, when the U.S. government increased note and bond offerings 59 percent to $922 billion as the recession and the financial crisis deepened.

The U.S. will sell $32 billion in three-year notes, $21 billion in 10-year debt and $13 billion in 30-year notes on three consecutive days starting July 9.

“The supply will be absorbed fairly well because of where rates are right now,” Franzese of ED&F Man said.

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