Treasuries 2nd Quarterly Gain Almost Wipes Out 2013 Loss

Treasuries rose for a second straight quarter, adding to first-half gains that erased almost all of 2013’s losses, as an uneven U.S. economic recovery and conflict in Iraq and Ukraine fueled haven demand.

U.S. government debt fluctuated today as a gauge of Chicago-area business activity fell more than forecast and pending home sales rose by the most in four years. Federal Reserve Bank of San Francisco President John Williams said recent data are “consistent” with an interest-rate increase during the second half of 2015. U.S. employers hired more than 200,000 workers for a fifth month, based on a Bloomberg News survey before the data July 3.

“You continue to see cautionary tones that have enveloped much of the market,” said Adrian Miller, director of fixed-income strategies at GMP Securities LLC in New York. “The growth trajectory is simply not going to be that strong this year.”

The benchmark 10-year yield closed little changed at 2.53 percent as of 5 p.m. in New York, according to Bloomberg Bond Trader data. The yield fell 19 basis points in the second quarter after a 31-basis-point drop in the first three months of the year. The price of the 2.5 percent note maturing in May 2024 was 99 23/32.

The Bloomberg U.S. Treasury Bond Index climbed 3.2 percent this year through the end of last week after declining 3.4 percent in 2013. The Bloomberg Global Developed Sovereign Bond Index rallied 4.9 percent in 2014 after falling 4.6 percent last year.

Williams’s View

“We won’t raise interest rates for some time,” Williams said in the text of a speech in Sun Valley, Idaho. Still, the Fed “can control short-term interest rates as needed to stem any inflationary pressures down the road.”

The central bank’s target for overnight lending between banks has been held in the range of zero to 0.25 percent since December 2008.

The Fed takes seriously the concern that its balance sheet poses inflationary and other risks as officials attempt to normalize policy, he said. Williams doesn’t vote on the Federal Open Market Committee again until 2015.

Treasury Supply

In the second half of 2014, the market will have to absorb $238 billion of Treasury supply, net of Fed purchases, compared with $133 billion in the first half of the year, according to Bank of America Merrill Lynch data, as the central bank phases out its bond-purchase program.

“Even if foreigners were to maintain the brisk pace of their Treasury buying in H2, primary U.S. domestic investors would need to increase their already high purchases by 70% compared to H1 -- all else equal -- in order for the market to clear,” strategists David Woo and Shyam Rajan wrote in a note to clients.

Foreign demand surged to $190 billion in the first half, from $209 billion in all of 2013, they said.

The Fed is unwinding bond buying under the quantitative-easing strategy it has used to support the economy, reducing monthly purchases to $35 billion from $85 billion last year. It is scheduled to purchase up to $21.8 billion in Treasuries, including inflation indexed debt, in 12 transactions in July. That is down from $27.6 billion bought in 16 transactions in June.

Treasuries have remained supported as global investors seek higher sovereign yields.

Extra Yield

The extra yield that benchmark U.S. 10-year notes offer over their Group of Seven counterparts was at 65 basis points. It touched 71 basis points on June 17, the most since April 2010. Yields in Europe have fallen after the European Central Bank earlier this month lowered interest rates and introduced new stimulus to stave off deflation and boost economic growth.

The Institute for Supply Management-Chicago Inc.’s business barometer fell to 62.6 in June from 65.5 the prior month. The median forecast of 45 economists in a Bloomberg survey projected the index would fall to 63. Estimates ranged from 60 to 66.5.

“We’ve shifted to lower, muddling growth expectations for the near-term,” said Ian Lyngen, a government-bond strategist at CRT Capital Group LLC in Stamford, Connecticut. “That doesn’t mean we won’t see strong growth later this year, but the first quarter was dismal and people aren’t expecting a complete bounce-back. It’s contributed to the grind lower in yields.”

Data remain mixed as the pending home sales index climbed 6.1 percent, the biggest advance since April 2010, after a revised 0.5 percent increase in April, the National Association of Realtors said today in Washington. The gain exceeded the most optimistic projection in a Bloomberg survey of economists, whose median forecast called for a 1.5 percent gain.

U.S. gross domestic product shrank at an annual rate of 2.9 percent in the first quarter, the worst reading since the same three months in 2009, the Commerce Department said last week.

FTN’s View

Jim Vogel and Chris Low of FTN Financial say that Treasuries are years away from reverting to pre-financial crisis levels as the labor market struggles. Among the few who correctly urged investors to ignore the consensus calling for an inevitable selloff in bonds this year, FTN’s head of interest-rate strategies and chief economist have since at least 2011 rightly gone against the pack by calling for low yields.

“If you don’t expect interest rates to go back to where they were in the last cycle, you’re essentially asserting that something is very different in this cycle,” Low said in a June 24 telephone interview. “You can make that case more easily with every year that goes by when growth remains weak and several hundred thousand people fall out of the labor force.”

FTN lowered its estimate today for the near-term range for the 10-year yield to 2.48 percent to 2.62, from 2.55 percent to 2.68 percent, citing “deteriorating expectations for the economy along with gradually shifting central-bank policies,” in a note to clients.

Yield Curve

Treasury 10-year yields will rise to 2.93 percent at the end of the third quarter and reach 3.12 percent by Dec. 31, according to a Bloomberg survey of economists, with the most recent estimates given the heaviest weighting.

The gap between yields on U.S. two-year notes and 30-year bonds, known as the yield curve was at 2.90 percentage points. It touched 2.86 percentage points on June 26, the least since May 2013, as investors as investors bet slower growth will keep the Fed from accelerating interest-rate increases forecast for next year.

The difference between yields on 10-year notes and similar-maturity Treasury Inflation Protected Securities, a gauge of trader expectations for consumer prices over the life of the debt, was 2.24 percentage points. The figure has climbed from this year’s low of 2.1 percentage points set in February. Disinflation is a slowing of inflation.

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