U.S. Treasury 5-Year Notes Extend Longest Drop This Year

Treasury five-year notes extended the longest losing streak this year as traders bet improving economic data will push the Federal Reserve to raise rates as early as July 2015.

The gap between five- and 30-year yields narrowed to almost the least in five years before the Federal Open Market Committee meets next week to discuss a stimulus-exit strategy. The chance of a rate increase to 0.5 percent or more by the end of next July is 58 percent, according to data compiled by Bloomberg based on federal fund futures, up from 43 percent at the end of last month. Long bonds rose as investors reached for higher yields amid U.S. data showing low inflation and unrest in Iraq.

The Fed “will be getting the market ready for the next phase -- they are at least going to start talking about raising interest rates,” said William Larkin, a money manager who oversees $520 million in assets at Cabot Money Management in Salem, Massachusetts. The recovery “is not optimal, but it’s going in the right direction.”

The five-year note yield rose for a third week, the longest streak since it gained the final six weeks in 2013, adding five basis points, or 0.05 percentage point, to 1.7 percent in New York, according to Bloomberg Bond Trader data. The price of the 1.5 percent security due May 2019 fell 7/32, or $2.19 per $1,000 face amount, to 99 2/32. The yield rose 11 basis points over the past three weeks.

The 30-year yield fell two basis points this week to 3.41 percent. Yields on benchmark Treasury 10-year notes added two basis points to 2.60 percent.

Yield Spread

The yield spread between five-year notes and 30-year bonds shrank to 168 basis points yesterday, after contracting to 167.8 on May 2, the least since September 2009.

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.

Hedge-fund managers and other large speculators decreased their net-long position in five-year note futures in the week ending June 10, according to U.S. Commodity Futures Trading Commission data.

Speculative long positions, or bet prices will rise, outnumbered short positions by 28,075 contracts on the Chicago Board of Trade. Net-long positions fell by 15,600 contracts, or 36 percent, from a week earlier, the Washington-based commission said in its

Inflation, Iraq

A report yesterday showed a 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.

Long bonds rose as President Barack Obama said he’ll consider over the next several days options to help Iraqi forces turn back militants sweeping across the country, threatening to ignite a civil war. Obama warned that the conflict can’t be resolved unless Iraq’s leaders bridge political differences.

Treasury 30-year bonds returned 12 percent this year, according to Bank of America Merrill Lynch Index, compared with 1.6 percent for the five-year note. The broader Treasury market returned 2.8 percent as of June 12, according to the index.

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

“The 30-year offers a substantial yield in comparison to other developed countries,” said Christopher Sullivan, who oversees $2.3 billion as chief investment officer at United Nations Federal Credit Union in New York. “Q2 will be less buoyant than people thought.”

‘Hawkish Statement’

Bank of England Governor Mark Carney said June 12 that the bank may raise its key interest rate.

“There’s already great speculation about the exact timing of the first rate hike and this decision is becoming more balanced,” Carney said. “It could happen sooner than markets currently expect.”

British 10-year gilt yields rose nine basis points on the week to 2.75 percent.

“You have a hawkish statement out of a central bank,” said 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. “That could mean the Fed may not be too far behind. Threes and fives have to start pricing for that.”

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.

The chance of a rate increase to 0.5 percent or more by the end of next year is 89 percent, according to the fed fund futures data.

Before it's here, it's on the Bloomberg Terminal.