Treasuries Rise as Services Output Decline Shows Uneven Recovery

Treasuries rose as an unexpected drop in a nonmanufacturing index last month showed an uneven economic recovery and fueled speculation the Federal Reserve will keep its interest-rate target at record lows.

Benchmark yields dropped from the highest level since July 2011 as the above-3-percent level attracted demand. Janet Yellen is poised for confirmation by the Senate today as head of the central bank, which begins reducing its bond-buying program this month and will release minutes of its December policy-makers meeting on Jan. 8. The U.S. will sell $64 billion of Treasuries maturing in three, 10 and 30 years this week.

“Pension funds and insurers have been waiting for these yield levels for a while, and without better fundamental news it will be hard to break through 3 percent sustainably,” said Guy LeBas, chief fixed-income strategist at Janney Montgomery Scott LLC in Philadelphia, which oversees $11 billion in fixed-income assets. “Inflation and economic growth will take a bigger part of the market’s focus.”

The benchmark 10-year yield fell four basis points, or 0.04 percentage point, to 2.96 percent at 5 p.m. in New York, according to Bloomberg Bond Trader prices. The 2.75 percent note maturing in November 2023 rose 10/32, or $3.13 per $1,000 face amount, to 98 7/32. The yield climbed to 3.05 percent on Jan. 2, the highest level since July 8, 2011.

Yield Levels

“The three-percent level in 10s is going to be a key level to breach in a down-trade,” said Ian Lyngen, a government-bond strategist at CRT Capital Group LLC in Stamford, Connecticut. “We haven’t sustainably been able to do that. The minutes may have a hawkish spin to them, keeping in mind the Fed decided to taper at this meeting. We might need a bit more of a setup to take down 10s and 30s at this level.”

The butterfly index spread, which measures how the 10-year note is performing against five- and 30-year debt, was at 32 basis points, almost the 34 basis points on Dec. 31, the cheapest level on a closing basis since December 2010. A positive reading indicates the market is bearish on the middle security, while a drop into negative figures indicates investors are more bullish.

The yield gap between five- and 30-year securities, known as the yield curve, dropped to 221 basis points after reaching 254 basis points on Nov. 20, the widest spread since September 2011.

U.S. government securities returned 0.1 percent as of Jan. 3, according to indexes compiled by Bank of America Merrill Lynch. They lost 3.4 percent in 2013, the first annual decline since 2009.

Economic Reports

The Institute for Supply Management’s nonmanufacturing index decreased to 53 in December from 53.9 in the prior month, a report from the Tempe, Arizona-based group showed today. The median projection in a Bloomberg survey of 69 economists was 54.7. Estimates ranged from 53 to 57.7.

Employers added 195,000 workers in December, down from 203,000 the previous month, a survey of economists showed before the Labor Department report on Jan. 10.

Officials shouldn’t rush to reduce stimulus, Fed Bank of Boston President Eric Rosengren said on the weekend.

Policy makers “have the opportunity to be patient in removing accommodation” with the inflation rate below 2 percent and unemployment above target, Rosengren said Jan. 4 at the American Economic Association’s annual meeting in Philadelphia. “This was one of the motivations for my dissenting vote,” he said, referring to his decision last month to cast the lone vote against starting tapering.

Fed Purchase

The Fed bought $1.39 billion in Treasuries today, acquiring securities due from May 2038 to August 2043.

The Federal Open Market Committee announced on Dec. 18 it would start reducing bond purchases in January to $75 billion a month from $85 billion. The Fed said “it likely will be appropriate to maintain the current target range for the federal funds rate well past” the 6.5 percent unemployment-rate threshold, especially if inflation stays below 2 percent. The benchmark rate has been a range of zero to 0.25 percent since 2008.

The U.S. plans to auction $30 billion in three-year notes tomorrow, $21 billion of 10-year securities the following day and $13 billion in 30-year bonds on Jan. 9.

“The auctions will be important and give a sense of what the market thinks about yields at these higher levels,” said Justin Lederer, an interest rate strategist at Cantor Fitzgerald LP in New York, one of 21 primary dealers that trade with the Fed. “Between the auctions, the jobs report and the Fed minutes there will be a lot to give the market direction this week.”

Futures Positions

Hedge-fund managers and other large speculators raised their net-short position on U.S. 10-year note futures in the week ended Dec. 31, according to U.S. Commodity Futures Trading Commission data. Speculative short positions, or bets prices will fall, outnumbered short positions by 173,674 contracts on the Chicago Board of Trade, almost the highest level since April.

The world’s biggest economies will need to refinance $7.43 trillion of sovereign debt in 2014 as bond yields begin to climb from record lows, threatening to raise borrowing costs while nations struggle to bring down elevated budget deficits.

The amount of bills, notes and bonds coming due for the Group of Seven nations plus Brazil, Russia, India and China is little changed from 2013 after dropping from $7.6 trillion in 2012, according to data compiled by Bloomberg. At $3.1 trillion, representing a 6 percent increase, the U.S. faces the largest tab. Russia, Japan and Germany will see refinancing needs drop, while those of Italy, France, Britain, China and India increase.

While budget deficits in developed nations have fallen to 4.1 percent of their economies from a peak of 7.8 percent in 2009, they remain about double the average in the decade before the credit crisis began. The cost for governments to borrow may rise further after average yields last year rose the most since 2006, as the global economy shows signs of improving and the Federal Reserve pares its unprecedented bond buying.

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