Treasuries Gain on Bets Fed Maintains Stimulus After Shutdown

Treasuries gained for the first time in three weeks as investors bet the Federal Reserve will delay tapering bond purchases after Congress’s deal to end a government shutdown pushed the budget battle into next year.

The yield on the benchmark 10-year note dropped to the lowest level in 12 weeks amid speculation the 16-day partial federal closure curbed economic growth. Rates on bills due this month dropped from the highest since issuance as the agreement averted a potential default. The U.S. September payrolls report, postponed by the shutdown, will be released Oct. 22.

“Given now the government shutdown and the lack of reliable employment economic indicators, it will probably be the first quarter before the Fed even starts to think about tapering,” said Gary Pollack, who manages $12 billion as head of fixed-income trading at Deutsche Bank AG’s Private Wealth Management unit in New York. “Interest rates can be supported at 2.5-to-2.75 percent by the end of the year. To get below 2.5 percent, you’ll have to see some weak economic data.”

The U.S. 10-year yield dropped by 11 basis points, or 0.11 percentage point, on the week to 2.58 percent in New York, according to Bloomberg Bond Trader prices. It 2.54 percent, the lowest level since July 24. The 2.5 percent note maturing in August 2023 cost 99 10/32.

Yields on 30-year bonds fell 11 basis points on the week to 3.64 percent after touching 3.62 percent, the lowest since Aug. 12.

Relative Strength

U.S. government securities reached the most expensive levels in almost three months, based on the 10-year term premium, a model that includes expectations for interest rates, growth and inflation.

The gauge fell yesterday to 0.21 percent, the lowest level since July 22. It declined from this year’s high of 0.63 percent set Sept. 5, signaling the cheapest levels of 2013. A positive reading indicates investors are getting yields that are above what is considered fair value.

The seven-day relative strength index for the Treasury 10-year note yield was at 32 yesterday, down from 40 the previous day and 67 on Oct. 15, according to Bloomberg data. A reading lower than 30 or above 70 suggests the security may be poised for a change in direction.

Economic Impact

“The idea that the Fed would taper right now is risky at best,” Matthew Duch, a fund manager in Bethesda, Maryland, at Calvert Investments, which oversees more than $12 billion in assets, said in a telephone interview Oct. 17. “If you think negotiations are going to be easier from here, you are being naive. And that has kept the longer end of the Treasury market well bid.”

The standoff over U.S. fiscal policy “encouraged our enemies” and slowed economic growth, President Obama said Oct. 17, when he signed into law the measure that ended weeks of a wrangling. The accord sets a Dec. 13 date for completing congressional budget talks that opened Oct. 17, funds government operations through Jan. 15 and suspends the debt limit through Feb. 7.

The government closing shaved at least 0.6 percent from U.S. fourth-quarter gross-domestic-product growth, Standard & Poor’s said this week in a report. The economy expanded 2.5 percent in the second quarter, the Commerce Department said on Sept 26.

Rates Plunge

Lending rates dropped after the shutdown ended. The overnight general collateral Treasury repurchase rate closed yesterday at 0.14 percent after closing at 0.35 percent on Oct. 16, the day before the debt-ceiling deadline, according to ICAP Plc, the world’s largest inter-dealer broker. It opened at 0.09 percent at the start of last week.

The rate on $93 billion of bills maturing on Oct. 24 was at 0.01 percent and touched zero yesterday after rising as high as 0.68 percent on Oct. 16. One-month rates were at 0.05 percent after surging on Oct. 16 to 0.45 percent, the highest level since October 2008. Bills due Nov. 21 dropped to negative levels for the first time in more than two weeks.

“There were buying opportunities in the bills market,” Paul Montaquila, fixed-income investment officer with BNP Paribas SA’s Bank of the West, said in a telephone interview Oct. 17. “It was a crazy ride. The bills market has returned to normalcy. The dust has settled.”

Even with the threat of a default, rates remained lower than historical levels, with one-month rates averaging 1.5 percent in the past decade and touching a high of 5.26 percent in November 2006.

Borrowing Costs

While the jump in bill rates proved short lived, the shutdown did cost the U.S. more to borrow.

The $35 billion in three-month bills the Treasury sold on Oct. 15 were auctioned at a discount rate of 0.13 percent, the highest since February 2011. That compares with 0.01 percent at the Sept. 30 auction. The U.S. sold $30 billion six-month bills the same day at a rate of 0.15 percent, more than double the 0.06 percent rate on the same maturity securities sold the prior week.

At the Fed’s September meeting, days before the shutdown, most policy makers said the central bank would probably reduce bond purchases this year from the current pace of $85 billion a month. They said in a statement they wanted to see more evidence of steady growth to combat 7.3 percent unemployment.

Economists now expect the Fed to delay the first cut to its bond-buying program until March, according to the median estimate of 40 economists in a Bloomberg News survey. In a Sept. 18-19 survey, economists said the central bank would first reduce the purchases in December.

Fed Views

Fed Bank of Chicago President Charles Evans, an outspoken advocate who has voted for Fed stimulus, said Oct. 17 the central bank should postpone tapering after the shutdown stopped the flow of economic reports used to gauge growth.

Even Dallas Fed President Richard Fisher, who has called for reducing asset purchases, told reporters the same day fiscal discord has undermined the argument for tapering.

The Federal Open Market Committee meets Oct. 28-29.

Fitch Ratings on Oct. 15 put the U.S. AAA rating on watch for a possible downgrade as the debt-ceiling deadline approached.

Moody’s Investors Service on Oct. 17 maintained its Aaa rating on the U.S., noting that the government’s borrowing-limit agreement includes “credit-positive elements.” S&P downgraded the U.S. on Aug. 5, 2011, by one notch to AA+ from AAA.

Even with this week’s rally, Treasuries have lost investors 2.15 percent this year, according to Bloomberg US Treasury Bond Index. The Bloomberg Global Developed Sovereign Bond Index has lost investors 2.7 percent in 2013.

The yield on the 10-year note is forecast to end the year at 2.76 percent, according to the median forecast of economists in a Bloomberg News survey. Most respondents were surveyed as of Oct. 10. The yield touched a 2013 high of 3.005 percent on Sept. 6.

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