Treasury 10-to-30-Year Curve Narrowest Since 2010 on Fed Outlook

The difference between yields on 10- and 30-year U.S. Treasuries narrowed to the least since 2010 after the Federal Reserve indicated interest rates may rise faster than anticipated while the pace of growth is moderate.

The U.S. sold $13 billion of 10-year Treasury Inflation Protected Securities at lower-than-average demand as the difference between yields on 10-year notes and similar maturity TIPS narrowed to the least in a month. Two-year notes extended yesterday’s drop, the most since 2011, as Fed Chair Janet Yellen suggested interest rates may rise by the middle of next year. Benchmark 10-year notes erased this week almost all of last week’s gains, the most since January, amid turmoil in Crimea.

“Inflation is low and now you have a Fed telling you they may raise rates earlier than the market had thought,” said Ray Remy, head of fixed income in New York at Daiwa Capital Markets America Inc., one of 22 primary dealers that trade with the Fed. “That’s generally good for bonds. If you believe the statement moved up the first rate hike, 30-years will outperform 10-years.”

The benchmark 10-year yield was little changed at 2.77 percent as of 5 p.m. in New York following yesterday’s increase of 10 basis points, according to Bloomberg Bond Trader prices. The price of the 2.75 percent security due in February 2024 was 99 26/32.

The 30-year bond yield rose one basis point to 3.66 percent. The two-year note yield was little changed at 0.42 percent after gaining seven basis points yesterday, the most since 2011. Five-year yields were little changed at 1.7 percent after touching 1.75 percent yesterday, the highest since Jan. 10.

Yield Gap

Treasury trading volume dropped 15 percent to $477 billion from $561 billion yesterday, according to ICAP Plc, the largest inter-dealer broker of U.S. government debt. Volume rose to $582.4 billion on March 13, the highest in more than nine months, according to ICAP.

The gap between the yields on the 10-year note and the 30-year bond narrowed to as little as 85.6 basis points, the least since May 2010.

“The bond doesn’t move off Fed policy,” said Tom Tucci, managing director and head of Treasury trading in New York at CIBC World Markets Corp. “It moves off inflation, growth and demand. The rest of the curve is a combination of fed funds and Fed policy. The effect of what you heard yesterday has more of an impact on the 10-year than the bond.”

Inflation measured on a 12-month basis has been below the Fed’s 2 percent goal for almost two years, and prices rose just 1.2 percent for the year ending January.

‘Underlying Strength’

“Growth in economic activity slowed during the winter months, in part reflecting adverse weather conditions,” the Fed said yesterday. Even so, “there is sufficient underlying strength in the broader economy to support ongoing improvement in labor-market conditions.”

Jobless claims increased by 5,000 to 320,000 in the week ended March 15, a Labor Department report showed. The median forecast of 51 economists surveyed by Bloomberg called for an increase to 322,000. The four-week average, a less volatile measure, fell to 327,000, the lowest level since late November.

As the economy improves, the Fed is slowly scaling back the large-scale bond purchases that have expanded its balance sheet to a record $4.18 trillion.

‘Flattening Trades’

“As you look toward a better economic environment and more Fed tightening, you do see more flattening trades,” said Jim Vogel, head of agency-debt research at FTN Financial in Memphis, Tennessee. “The 10-year that had been held down by global developments was free from those for a day or two. The 30-year has been anchored by good sponsorship of the long end of the curve.”

The Fed said it will look at a wide range of data in determining when to raise its benchmark interest rate from zero, dropping a pledge tying borrowing costs to a 6.5 percent unemployment rate.

Benchmark U.S. government debt fell this week as Ukraine ceded control of Crimea to Russia, saying demilitarizing the Black Sea region “is the best way to de-escalate the situation,” Andriy Parubiy, head of Ukraine’s National Security Council, told reporters in Kiev yesterday.

Today, President Barack Obama said at the White House that the U.S. is imposing additional sanctions on Russian officials and that its support for NATO allies is “unwavering.” In retaliation, the Russian government barred entry of nine U.S. officials, including House Speaker John Boehner of Ohio and Senate Foreign Relations Committee Chairman Robert Menendez of New Jersey.

Break-Evens

The TIPS sold today had a bid-to-cover ratio, which gauges demand by comparing total bids with the amount of notes offered, of 2.48 today, below the average of 2.52 at the previous 10 sales. They drew a yield of 0.659 percent, compared with the 0.652 percent average forecast of six of the Fed’s primary dealers.

The difference between the yields on 10-year notes and similar maturity TIPS, a gauge of the outlook for consumer prices over the life of the debt known as the break-even rate narrowed to as little as 2.13 percentage points, matching the least since Feb. 7.

The Treasury will sell $32 billion in two-year notes, $35 billion in five-year debt and $29 billion in seven-year securities on three consecutive days starting March 25. It will sell $13 billion in two-year floating-rate notes on March 26.

The Treasury 10-year note yield spread over similar maturity Group of Seven peers was 0.57 percentage point after rising to 0.62 percentage point yesterday, the most since April 2010.

Economists and strategists in a Bloomberg News survey lowered their forecasts for how much the 10-year yield will increase at year-end. The rate will rise to 3.35 percent in the fourth quarter, according to a survey conducted March 7-12, down from 3.40 percent in a survey last month.

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