Treasuries Fall Second Day as Economy Expands More Than Forecast

Treasuries dropped for a second day as a report showed the economy expanded last quarter faster than previously forecast, boosting speculation the Federal Reserve will reduce the pace of bond purchases as soon as next month.

Benchmark 10-year yields pared gains on reports a fifth U.S. destroyer was headed to the eastern Mediterranean before a potential strike on Syria. The economy grew at a 2.5 percent annual pace in the second quarter, more than forecast and up from the previous estimate of 1.7 percent, while weekly jobless claims fell more than projected. The U.S. plans to auction $29 billion of seven-year debt after a sale of five-year notes yesterday drew the least demand in four years.

“Tapering is there, one data point isn’t going to make a difference now,” said David Ader, head of U.S. government bond strategy at CRT Capital Group LLC in Stamford, Connecticut, referring to the Fed’s plans. “We are in this nervous equilibrium and that will create short-term volatility.”

The U.S. 10-year yield increased two basis points, or 0.02 percentage point, to 2.79 percent at 11:21 a.m. New York time, after adding six basis points yesterday, according to Bloomberg Bond Trader prices. The 2.5 percent note due in August 2023 fell 6/32, or $1.88 per $1,000 face amount, to 97 17/32.

The yield climbed as much as six basis points earlier and reached 2.93 percent on Aug. 22, the most since July 2011.

Index Extension

U.S. debt saw month-end buying to match market indexes. Funds that manage portfolios against benchmark indexes, including the Barclays U.S. Aggregate Index, typically buy longer-maturity Treasuries at almost month-end to align the interest rate sensitivity of their holdings with the indexes.

The Barclays index will extend its duration, the measure of rate-sensitivity, by 0.11 year on Sept. 1, compared with 0.10 year on Aug. 1.

Treasuries lost 3.3 percent this year through yesterday, including 0.8 percent in August, according to Bloomberg U.S. Treasury Bond Index.

The seven-year notes being sold today yielded 2.25 percent in pre-auction trading, compared with 2.026 percent at the previous auction on July 25. Investors bid for 2.54 times the amount offered last month compared with 2.61 at the June sale.

Auction Detail

Indirect bidders, the category of investors that includes foreign central banks, purchased 48.6 percent of the securities last month, primary dealers bought 34.9 percent and direct bidders purchased 16.6 percent.

The five-year notes sold yesterday had a bid-to-cover ratio of 2.38, the lowest since July 009 and compared with an average of 2.74 for the past 10 sales. They drew a yield of 1.624 percent, compared with a forecast of 1.618 percent in a Bloomberg survey of eight of the Fed’s 21 primary dealers.

Treasuries pared losses as the U.S. bolsters forces in preparation for a potential strike on Syria. The USS Stout is en route to join four destroyers already in the region, according to a defense official who asked not to be identified discussing military preparations.

“People are speculating there may be a strike over the weekend,” said Dan Mulholland, head of Treasury trading at BNY Mellon Capital Markets in New York.

Syria Watch

Treasuries rose earlier this week on speculation the U.S., France and Britain were moving closer to military action against Syria after the nation’s government allegedly used chemical weapons against civilians.

U.S. President Barack Obama and U.K. Prime Minister David Cameron face a decision whether to attack Syria without a UN mandate amid Russian resistance, demands for consultation from lawmakers at home and domestic opposition to involvement in another conflict in the Middle East.

The Fed bought $1.6 billion of securities maturing from February 2036 to February 2043 today, according to the New York Fed’s website. Debate about when policy makers will start to taper the $85 billion in monthly bond buying has roiled financial markets around the world in the past three months and sparked a selloff in fixed-income assets.

“Tapering is almost a done deal unless you get a real bad employment number in September,” said Thomas Roth, senior Treasury trader in New York at Mitsubishi UFJ Securities USA Inc.

The economy expanded at a faster pace in the second quarter as a smaller trade deficit and gains in inventories overshadowed the effects of federal budget cutbacks. GDP growth topped the median forecast of 79 economists surveyed by Bloomberg projected a 2.2 percent gain.

Jobless claims in the week ended Aug. 24 dropped 6,000 to 331,000 from a revised 337,000 the week before that was higher than initially reported, the Labor Department said. The median forecast of 50 economists surveyed by Bloomberg called for a drop to 332,000.

“It’s putting a little bit of pressure on Treasuries going into the seven-year auction,” Mitsubishi’s Roth said.

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