Treasury Yield Curve Narrows as U.S. Readies 3-Year Note Auction

The extra yield that investors demand to hold 10-year notes instead of three-year debt fell from almost the highest level since 2011 as investors assess the Federal Reserve’s case for additional stimulus tapering.

Benchmark 10-year note yields dropped for a second day as the rise above the 3-percent level to a more-than-two-year high last week spurred demand. The U.S. will auction $30 billion of three-year notes today, $21 billion of the 10-year securities tomorrow and $13 billion of 30-year bonds Jan. 9. Investors increased neutral positions to the highest level in more than five months, according to a survey by JPMorgan Chase & Co.

“There’s obviously cash to be put to work,” said Thomas Roth, senior Treasury trader in New York at Mitsubishi UFJ Securities USA Inc. “The market is going to be much more driven by what happens in the economy.”

The three-year yield was at 0.76 percent at 11:23 a.m. New York time, after dropping to 0.74 percent on Jan. 3, the lowest level since Dec. 23. The price of the 0.625 percent note maturing in December 2016 was 99 5/8.

The benchmark 10-year yield was at 2.95 percent after climbing to 3.05 percent on Jan. 2, the highest since July 2011. The spread between three- and 10-year yields was 220 basis points, or 2.20 percentage points. It reached 230 basis points on Dec. 6, the widest since July 2011.

Expensive Debt

Three-year notes are trading at almost the most expensive levels in more than two years, compared with two- and five-year debt.

The butterfly index spread, which measures how the three-year note is performing against the other two securities, is at negative 58 basis points, almost negative 61 basis points set on Dec 19, the most expensive level since July 2011. A negative figure indicates investors are more bullish on the middle of the three securities, making it relatively expensive versus the others.

Treasury trading volume at ICAP Plc, the largest inter-dealer broker of U.S. government debt, rose yesterday to $232.6 billion, the highest level since Dec. 20. It averaged $307.7 billion in 2013.

Investors in Treasuries posted the highest levels of neutrals since July in the week ending yesterday, according to a survey by JPMorgan. Investors raised neutral bets to 72 percent from 65 percent in the week ending Dec. 16, the survey reported.

Investor Sentiment

The proportion of net shorts was at two percentage points in the week ending yesterday, down from five percentage points, according to JPMorgan. The percent of outright shorts, or bets the securities will drop in value, slipped to 15 percent from 20 percent in the week ending Dec. 16, the survey said. The percent of outright longs dropped to 13 percent from 15 percent, the survey reported.

“There’s a lot of cash on the sidelines that needs to be put to work,” said Charles Comiskey, head of Treasury trading in New York at Bank of Nova Scotia, one of 21 primary dealers that trade with the Fed. Investors “are trying to get the truth on where the economy stands. As time moves on we are constantly being data-dependent.”

The three-year notes scheduled for sale today yielded 0.81 percent in pre-auction trading, compared with 0.63 percent at last month’s auction.

The previous sale of three-year notes on Dec. 10 attracted bids for 3.55 times the amount offered, the highest level since February. Indirect bidders, the investor class that includes foreign central banks, bought 38.4 percent, the most since August.

Debt Returns

Treasuries due in one to three years returned 0.3 percent in 2013, based on the Bloomberg U.S. Treasury Bond Indexes. Debt maturing in 10 years and longer slumped 12 percent.

U.S. government securities rose yesterday as a decline in a services index added to evidence the economic recovery is uneven.

“As long as we remain below 3 percent, it keeps a lot of the bears at bay,” said Michael Franzese, senior vice president of fixed-income trading at ED&F Man Capital Markets in New York, referring to the 10-year yield.

Fed Bank of Boston President Eric Rosengren, the only dissenter against a Fed decision to taper bond-buying, said policy makers should avoid hurting the economy and cut stimulus “only very gradually.”

Fed View

“This recovery has already been too slow, and we do not want premature tightening of monetary policy to delay the return to more normal economic conditions,” Rosengren said in a speech in Hartford, Connecticut. “A very gradual normalization is very appropriate given that the unemployment rate remains unusually high and the inflation rate remains unusually low.”

U.S. employers added 195,000 workers last month, down from 203,000 in November, economists in a Bloomberg survey forecast before the Labor Department reports the figure Jan. 10. The unemployment rate, derived from a separate Labor Department survey of households rather than employers, is estimated to stay at a five-year low of 7 percent.

Janet Yellen yesterday won Senate confirmation to succeed Ben S. Bernanke as Fed chairman. As Fed vice chairman, Yellen backed Bernanke’s efforts to steer the economy through its most severe crisis since the 1930s with record-low interest rates and three rounds of bond buying that have swelled Fed assets to $4.02 trillion.

The central bank said Dec. 18 it will cut its bond purchases, which focus on mortgage debt and longer-term Treasuries, to $75 billion a month from $85 billion starting in January. The policy committee reaffirmed its view that the target for the federal funds rate that banks charge each other on overnight loans will stay close to zero at least as long as the unemployment rate is more than 6.5 percent.

Policy makers are scheduled to issue the minutes of the meeting tomorrow.

A Bloomberg survey of economists with the most recent forecasts given the heaviest weightings projects 10-year yields will be 3.40 percent by year-end.

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