Treasury Yield Curve Flattens Amid Fed Rate Speculation

The U.S. Treasury yield curve approached the flattest level in almost five years as investors speculated the Federal Reserve may raise interest rates sooner than forecast.

Longer-maturity bonds have outperformed this week on signs of an uneven U.S. recovery and as investors sought a haven heading into the weekend amid turmoil in Iraq and and Ukraine. The difference between five- and 30-year yields fell toward the narrowest since 2009, even as the difference in yields between two- and five-year notes widened. Gilts dropped after Bank of England Governor Mark Carney said yesterday that the bank may raise its key interest rate earlier than investors expect.

“The Bank of England is a little bit ahead of the Fed in the path they’re both presumably taking,” said Jason Rogan, managing director of U.S. government trading at Guggenheim Securities, a New York-based brokerage for institutional investors. “Due to geopolitical risk, you’re seeing some flight to safety.”

The 30-year yield was little changed at 3.41 percent at 5 p.m. New York time, according to Bloomberg Bond Trader data. The 3.375 percent bond maturing in May 2044 cost 99 9/32. The yield fell two basis points this week.

Yields on benchmark Treasury 10-year notes rose one basis point, or 0.01 percentage point, to 2.60 percent and added two basis points on the week.

Yield Curve

Five-year yields climbed one basis point to 1.69 percent and posted a five basis-point weekly increase. The yield spread between five-year notes and 30-year bonds shrank to as narrow as 168 basis points today, after contracting to 167.8 on May 2, the least since September 2009.

“You have a hawkish statement out of a central bank,” Ira Jersey, an interest-rate strategist in New York at Credit Suisse Group AG, one of 22 primary dealers that trade directly with the Fed, said of the Bank of England. “That could mean the Fed may not be too far behind. Threes and fives have to start pricing for that. That part of the curve is vulnerable to hawkish central bank policy.”

Shorter maturities are more sensitive to what the Fed does with interest rates, while longer-dated debt is more influenced by the outlook for inflation.

Economic Indicators

The spread briefly widened after wholesale prices in the U.S. unexpectedly fell in May. The 0.2 percent decrease in the producer price index compared with the median estimate in a Bloomberg survey of 71 economists that called for a 0.1 percent gain. Over the past 12 months, costs climbed 2 percent, figures from the Labor Department showed today.

Treasuries pared losses after the Thomson Reuters/University of Michigan preliminary sentiment index unexpectedly fell to 81.2 for June from 81.9 the previous month. Economists in a Bloomberg News survey had forecast the index would rise to 83.

Retail sales advanced 0.3 percent in May, the Commerce Department said yesterday, half the gain projected by economists. Import prices, another gauge of inflation, increased 0.1 percent, also half the increase predicted.

The Fed is reducing its monthly bond purchases, while keeping the target for overnight lending between banks in a range of zero to 0.25 percent. Policy makers signaled at their April 29-30 meeting that interest rates will stay low for a “considerable time.” They next meet on June 17-18.

Fed Exit

The central bank’s exit from stimulus has the potential to be problematic, Fed Reserve Bank of Boston President Eric Rosengren said in a speech in Guatemala City on June 9. That fueled speculation officials are more actively considering the process of policy normalization, according to DZ Bank’s Cossor.

The chance of a rate increase to 0.5 percent or more next year is 88.7 percent, according to data compiled by Bloomberg based on federal fund futures.

The Standard & Poor’s 500 Index of shares fell the most in three weeks yesterday after President Barack Obama said he won’t rule out using air strikes to help Iraq’s government battle Islamic militants who threaten to ignite a civil war.

“The data remains very soft, and the geopolitical risks are just too great at this point to not be involved in U.S. government bonds,” said Thomas di Galoma, head of fixed income rates at ED&F Man Capital Markets in New York. “There could be more issues out of Iraq over the weekend, so you’re starting to see the shorts take some chips off the table.” Shorts are bets that the price of a security will fall.

Oil for July delivery climbed to as high as $107.68 a barrel in electronic trading on the New York Mercantile Exchange, the most since September. The average over the past decade is about $79.

The Bloomberg Global Developed Sovereign Bond Index returned 4 percent this year through yesterday, compared with a 4.6 percent loss in 2013.

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