Treasuries Drop Most in More Than Month on Manufacturing

Benchmark Treasury 10-year notes declined the most in more than a month after U.S. manufacturing expanded in May at the fastest pace this year.

Ten-year notes fell for a third day as a gauge of Chinese manufacturing climbed to a five-month high. The securities extended the drop as the Institute for Supply Management corrected its reported output at U.S. factories in May to a stronger number on an adjustment error. A non-farm payrolls report June 6 is forecast to show the U.S. added more than 200,000 jobs for a fourth month in May.

“When we get some better economic numbers, 2.40 percent-2.45 percent is just a difficult level to hold,” said Kevin Flanagan, a Purchase, New York-based fixed-income strategist for Morgan Stanley Smith Barney. “This is going to be a very important week for the Treasury market in trying to justify the rally of last week.”

The benchmark Treasury 10-year yield rose five basis points, or 0.05 percentage point, to 2.53 percent as of 5 p.m. New York time, the biggest gain since April 17. The price of the 2.5 percent note due in May 2024 fell 14/32, or $4.38 per $1,000 face value, to 99 24/32.

The yield dropped to 2.40 percent on May 29, the lowest level since June 21, and declined six basis points last week.

Yield Spread

Treasury two-year yields were at the highest level relative to similar-dated German debt since 2012 on speculation the European Central Bank will cut interest rates this week as the Federal Reserve slows stimulus.

The yield difference, or spread, between the securities widened to 33 basis points, the most since August 2012, based on closing-price data.

Treasury two-year yields rose one basis point to 0.39 percent, according to Bloomberg Bond Trader data. The rate on similar-maturity German debt fell as much as two basis points to 0.044 percent, the lowest since May 2013.

ECB President Mario Draghi and fellow policy makers have signaled measures from negative deposit rates to conditional liquidity for banks could be used to avert the threat of deflation in the euro area.

Of 50 economists surveyed by Bloomberg News, 44 expect the ECB to become the first major central bank to take interest rates below zero by cutting its deposit rate on June 5. All but two of 60 respondents in a separate Bloomberg survey said the main refinancing rate would also be lowered.

“It’s central-bank intervention that’s causing the disparities” between U.S. and German securities,’’ said Charles Comiskey, New York-based head of Treasury trading in New York at Bank of Nova Scotia, one of 22 primary dealers that trade directly with the Fed. “This is a big week with the ECB and NFP -- Friday’s report will give us more direction.”

Fed Buying

The Fed has undertaken the biggest stimulus program in its 100-year history to boost economic growth amid concern the strategy would ignite inflation. It has increased its balance sheet to $4.3 trillion since 2008 in bond purchases designed to lower longer-term borrowing costs and fuel growth.

Officials have reduced monthly buying to $45 billion this year, from $85 billion in 2013, amid signs of the economy is beginning to respond.

The ISM’s U.S. factory index rose to 55.4 last month from 54.9 in April, the Tempe, Arizona-based group’s report showed today. It initially reported a drop to 53.2 and subsequently said it rose to 56. Readings above 50 indicate expansion. The median forecast of 82 economists surveyed by Bloomberg called for 55.5.

Treasuries Rally

A government report on June 6 will show the U.S. added 215,000 jobs in May, versus 288,000 in April, based on responses from economists in a separate Bloomberg survey.

The China Purchasing Managers’ Index climbed to 50.8 in May, the nation’s statistics bureau said yesterday. The figure is the highest this year and compares with the 50.7 median estimate of analysts surveyed by Bloomberg News. Numbers above 50 indicate expansion.

This year’s rally in Treasuries has thwarted economists, who have been predicting losses, based on Bloomberg surveys of banks and securities companies. The latest forecast is for 10-year yields to rise to 3.25 percent by Dec. 31, with the most recent forecasts given the heaviest weightings.

Speculative short positions on 10-year futures, or bets prices will fall, outnumbered longs by 19,078 contracts on the Chicago Board of Trade for the week ended May 27, according to the Commodity Futures Trading Commission. It was the smallest short position since February.

Globally, bonds have returned an average 3.9 percent this year for the biggest year-to-date gain since 2003, index data compiled by Bank of America Merrill Lynch show.

The Bloomberg U.S. Treasury Bond Index rose 1 percent in May, pushing its gain for 2014 to 3.4 percent. The Bloomberg Global Developed Sovereign Bond Index advanced 0.4 percent last month, and is up 4.3 percent this year.

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