Treasury Yield Curve Narrows to Least in 3 Months Amid Fed Bets

The yield gap between 10- and 30-year Treasuries shrank to the narrowest in almost three months on speculation inflation will remain in check as the Federal Reserve prepares to slow bond purchases.

The benchmark 10-year note yield fell from a one-week high after wholesale prices in the U.S. declined for a third month. It rose yesterday after data showed retail sales jumped more than forecast in November. The House of Representatives passed the first bipartisan federal budget in four years, fueling bets fiscal progress will make it easier for the Fed to reduce monthly bond purchases.

“The market isn’t worried about inflation, so the Fed tapering might even make some concerned that inflation might fall even quicker if the Fed isn’t there buying assets,” said Guy Haselmann, an interest-rate strategist in New York at Bank of Nova Scotia, one of 21 primary dealers that trade with the U.S. central bank.

The spread between 10- and 30-year yields was 1.01 percentage points, the narrowest since Sept. 17, at 5 p.m. in New York, according to Bloomberg Bond Trader data. It was 1.13 percentage points on Nov. 6, the widest since June.

The 10-year yield declined one basis point, or 0.01 percentage point, to 2.87 percent after touching 2.89 percent earlier, the highest since Dec. 6. It fell to as low as 2.85 percent and was up less than one basis point on the week. The price of the 2.75 percent security maturing in November 2023 added 3/32, or 94 cents per $1,000 face amount, to 99. Thirty-year bond yields fell two basis points to 3.87 percent.

Treasury Loss

U.S. government securities lost 2.9 percent this year through yesterday, Bloomberg World Bond Indexes show. They returned 2 percent in 2012.

A gauge of Treasuries volatility slipped from the highest level in a week. The Bank of America Merrill Lynch MOVE Index declined to 72.61 after reaching 72.8 yesterday, the highest since Dec. 5. It dropped on Nov. 18 to a six-month low of 58.31.

Hedge-fund managers and other large speculators maintained their net-long position on U.S. five-year notes futures at almost the biggest in four months in the week ended Dec. 10, according to U.S. Commodity Futures Trading Commission data. Speculative long positions, or bets prices will rise, outnumbered short positions by 26,627 contracts on the Chicago Board of Trade. They were at 29,353 the previous week, the most since Aug. 16.

Treasuries fell yesterday as the Commerce Department reported that retail sales climbed 0.7 percent, beating a forecast for a gain of 0.6 percent. The Labor Department reported Dec. 6 U.S. employers added more workers in November than economists forecast, swelling payrolls by 203,000 jobs, and that the jobless rate dropped to a five-year low of 7 percent.

‘Higher Yields’

“We’ve had a string of economic data that’s been better than expected,” said Thomas Roth, senior Treasury trader in New York at Mitsubishi UFJ Securities USA Inc. “The path of least resistance is still to higher yields.”

The Fed buys $85 billion of bonds each month to push down borrowing costs and fuel economic growth. It purchased $1.58 billion today of Treasuries due from May 2038 to February 2043 as part of the program.

The Federal Open Market Committee will start slowing the purchases at its Dec. 17-18 meeting, according to 34 percent of economists surveyed Dec. 6 by Bloomberg, an increase from 17 percent in a Nov. 8 survey. Others predicted tapering will start next year.

Minutes of the Fed’s Oct. 29-30 meeting, released Nov. 20, showed policy makers expected economic data to indicate improvement in the labor market and “warrant trimming the pace of purchases in coming months.” The central bank’s mandate is to ensure both full employment and price stability.

Producer Prices

The U.S. producer price index fell 0.1 percent in November following a 0.2 percent decrease the prior month, the Labor Department reported today. A Bloomberg survey of 77 economists called for no change. The so-called core measure, which excludes food and energy, rose 0.1 percent.

“We know that’s not the Fed’s preferred measure of inflation, but the Fed’s preferred measure of inflation is extremely low also,” said Michael Lorizio, senior trader at Manulife Asset Management in Boston. “This lends more to the argument that if the inflation portion of their dual mandate is nowhere near their goal, until it’s near their goal how can they tighten policy?”

The central bank’s preferred gauge of inflation, the personal consumption expenditures deflator, last week showed price gains slowed to 0.7 percent in October, the least since 2009. The gauge has failed to meet the Fed’s 2 percent target for 18 months.

Benchmark Rate

The Fed has kept its benchmark interest-rate target at zero to 0.25 percent since 2008 to support the economy. Fed Chairman Ben S. Bernanke said last month the rate will probably stay low long after bond buying ends.

The extra yield Treasury 10-year notes offer over the U.S. inflation rate was about 1.86 percentage points. The real yield climbed to 1.91 percentage points on Dec. 12, the highest level since February 2011, according to data compiled by Bloomberg based on closing prices.

The Treasury will sell $32 billion in two-year notes on Dec. 17, $35 billion in five-year securities the following day and $29 billion of seven-year debt on Dec. 19. It will also auction $16 billion in five-year inflation-protected securities on Dec. 19.

Treasuries Holdings

Foreign central banks’ holdings of Treasuries held at the Fed breached $3 trillion for the first time as nations intervening in the currency markets plowed dollars back into U.S. government debt.

Overseas central banks lifted the amount of Treasuries held for them by the Fed this month to $3.007 trillion, Fed data released yesterday showed. That’s more than double the $1.162 trillion held at the start of 2007. The Bloomberg U.S. Treasury Bond Index is up 15 percent since January 2010, when Bloomberg began calculating the data.

House passage of a U.S. budget in a 332-94 vote yesterday cleared the way for final Senate approval next week to ease $63 billion in spending cuts and avert another government shutdown. The compromise budget was crafted by Democratic Senator Patty Murray and Republican Representative Paul Ryan. President Barack Obama said he’ll sign the final measure.

Before it's here, it's on the Bloomberg Terminal.