Treasuries Decline on Taper Speculation Before Fed Opens Meeting

Treasuries fell, pushing 10-year note yields toward the highest level in a week, before the Federal Reserve decides at a two-day meeting whether to start slowing bond purchases used to keep borrowing rates low and sustain the economic recovery.

The difference between the yields on five- and 10-year notes reached the narrowest in a month as investors bet improving economic data may usher in a reduction in stimulus. The Fed will probably start tapering purchases this week after unexpectedly maintaining them in September, according to 34 percent of economists surveyed Dec. 6 by Bloomberg, an increase from 17 percent in a Nov. 8 survey.

“The question for the Fed will be, ‘is the growth sustainable enough to taper this month?’” said Larry Milstein, managing director in New York of government-debt trading at R.W. Pressprich & Co. “The market is pretty well split on that prospect. Because of that, we shouldn’t stray far from these levels.”

The benchmark U.S. 10-year yield rose one basis point, or

0.01 percentage point, to 2.88 percent at 5 p.m. in New York, according to Bloomberg Bond Trader prices. The yield, which on Dec. 13 reached a one-week high of 2.89 percent, fell earlier to

2.84 percent. The price of the 2.75 percent note due in November 2023 declined 1/8, or $1.25 per $1,000 face amount, to 98 29/32.

Five-year notes yielded 1.53 percent after touching 1.55 percent on Dec. 13, the highest since Sept. 18.

Yield Difference

The gap between the yield on five- and 10-year Treasury notes narrowed to 1.34 percentage points. It touched 1.32 percentage points earlier, the narrowest since Nov. 13. The gap increased on Nov. 21 to 1.45 percentage points, the widest since August 2011.

“The market is long in the front end,” said Tom Tucci, managing director and head of Treasury trading in New York at CIBC World Markets Corp. The five-year note is “pricing in stronger economic news and tapering.” Long positions are bets a security will increase in value.

Treasury trading volume at ICAP Plc, the largest inter-dealer broker of U.S. government debt, declined 17 percent to $193 billion, from $232 billion on Dec. 13. The average this year is $311 billion.

A gauge of Treasuries volatility increased for a fourth week, the longest stretch since September, in the five days ended Dec. 13. The Bank of America Merrill Lynch MOVE index rose

4.9 percent, the most since the week ended Nov. 22, to 72.6 and touched 72.8. The past year’s weekly average is 71.1.

China’s Holdings

China, the largest foreign creditor to the U.S., increased its ownership of Treasuries in October to almost the record level it reached in July 2011 after the Fed unexpectedly opted not to slow bond buying in September. It added $10.7 billion, or

0.8 percent, to bring its holdings to $1.3 trillion, U.S. Treasury data show.

Treasuries lost 2.8 percent in 2013 through Dec. 13, Bloomberg World Bond Indexes showed, as investors prepared for the Fed to start tapering.

The Fed, which opens its December meeting tomorrow, buys $85 billion of Treasury and mortgage bonds a month. It purchased $3.18 billion in Treasuries today maturing from August 2022 to August 2023 as part of the program.

“A modest tapering is baked in -- $5 billion to $10 billion is expected, and then they will gradually increase it,” said Brian Edmonds, the head of interest-rates trading in New York at Cantor Fitzgerald LP, one of 21 primary dealers that trade with the Fed. “I don’t expect any big spikes in rates. There may be a knee-jerk reaction. With no spike in inflation, we won’t see a real spike” in rates.

Surprised Traders

Policy makers surprised traders and roiled markets across the globe on Sept. 18 by maintaining monthly purchases after Fed Chairman Ben S. Bernanke said in May he might taper “in the next few meetings” of the Federal Open Market Committee.

Minutes of the Oct. 29-30 FOMC meeting, released Nov. 20, said officials expected economic data to show improvement in the labor market and “warrant trimming the pace of purchases in coming months.”

The U.S. jobless rate fell to a five-year low of 7 percent in November, retail sales gained more than forecast, manufacturing expanded at the fastest pace in more than two years and purchases of new U.S. homes surged to the most in three decades, reports this month showed.

Treasuries rose Dec. 13 after the U.S. producer price index unexpectedly declined 0.1 percent in November from October.

“Whether we see tapering is a toss-up,” said Guy LeBas, chief fixed-income strategist at Janney Montgomery Scott LLC in Philadelphia, which oversees $11 billion in fixed income assets. “We’ve seen improvement in the job market, and there is minimal risk of a government shutdown, but inflation is still very low and not showing any signs of rising.”

Inflation Outlook

The difference between yields on 10-year notes and similar-maturity Treasury Inflation Protected Securities, a gauge of trader expectations for consumer prices over the life of the debt called the break-even rate, was 2.18 percentage points. The average over the past decade is 2.22 percentage points.

TIPS are suffering unprecedented losses after inflation in the U.S. rose 1 percent last month, the smallest increase since

2009. The bonds have plunged 8.8 percent this year, the most since they were introduced in 1997, according to Bank of America Merrill Lynch indexes.

Policy makers have kept their target rate for federal funds, which banks charge each other on overnight loans, at zero to 0.25 percent since 2008 to support the economy. The odds of an increase by January 2015 are about 16 percent, based on data compiled by Bloomberg from federal funds futures.

Note Auctions

The Treasury is scheduled to sell $112 billion in notes this week, including $32 billion in two-year debt tomorrow, $35 billion in five-year securities the next day and $29 billion of seven-year notes on Dec. 19. It will also auction $16 billion in five-year Treasury Inflation Protected Securities Dec. 19.

Bonds rose earlier as a slowdown in Chinese manufacturing growth stoked concern the pace of the global recovery may flag.

The preliminary reading for the China Purchasing Managers’ Index issued by HSBC Holdings Plc and Markit Economics slipped to 50.5 from 50.8 in November. A Bloomberg News survey called for 50.9. A number above 50 indicates expansion.

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