Treasuries Rally Most in 4 Months as European Stress Adds Allure

Treasuries rose, with 10-year yields posting the biggest drop in almost four months, as re-emerging financial stress in Europe spurred refuge demand.

Benchmark 10-year yields touched a five-week low on concern Banco Espirito Santo SA, Portugal’s second-biggest lender, would become embroiled in the financial woes of a parent company after a missed payment on short-term debt by a member of the banking group. Treasuries gained as minutes of the Federal Reserve June policy meeting eased concern the central bank would move up its plans for an interest-rate increase next year. Fed Chair Janet Yellen is set to testify before Congress for two days commencing July 15.

“The Portuguese banking event highlights the concern and uncertainties in the European Union and that, combined with disappointments about growth globally, has sent investors looking for safety,” said Christopher Sullivan, who oversees $2.3 billion as chief investment officer at United Nations Federal Credit Union in New York. “There was an expectation that the Fed would be more hawkish, and they weren’t, which supports the idea that there is a strong backdrop for Treasuries.”

The 10-year yield fell 12 basis point this week, or 0.12 percentage point, to 2.52 percent in New York, the most since the five days ended March 14, according to Bloomberg Bond Trader prices. The price of the 2.5 percent note due in May 2024 rose 1 2/32, or $10.63 per $1,000 face amount, to 99 27/32. The yield reached 2.49 percent, the lowest since June 2.

Relative Value

The Bloomberg U.S. Treasury Bond Index returned 3.2 percent this year, while the Bloomberg Global Developed Sovereign Bond Index gained 4.9 percent.

The difference between the yields on Treasury five-year notes and 30-year bonds was at 1.70 percentage points. The figure is up from 1.64 percentage points on July 9, the narrowest since March 2009.

Hedge-fund managers and other large speculators increased bets on a decline in 10-year notes in the week ending July 8, according to U.S. Commodity Futures Trading Commission data. Speculative net-short positions, or bets prices will fall, rose to 97,772 contracts, from 69,358 the week before.

Speculators reversed positions in futures on Treasury bonds to a 4,357 net-short position, compared with a 17,737 net-long position the previous week, CFTC data show. It was the largest net-short since October.

Debt Sales

Treasuries rallied even as the market absorbed $61 billion of notes and bonds auctioned this week.

The $13 billion sale of 30-year bonds on June 10 at a yield of 3.369 percent attracted the most demand in more than eight years from a class of investors that includes foreign central banks amid signs of financial stress in European markets and relatively attractive U.S. yields. Indirect bidders purchased 53.2 percent of the debt at the auction, the highest level since the February 2006 offering of the securities.

The U.S. sold $27 billion of three-year debt on July 8 at a yield of 0.992 percent and auctioned $21 billion of 10-year debt July 9 at a yield of 2.597 percent.

The extra yield that 10-year Treasuries offer over their Group-of-Seven counterparts was 67 basis points. It touched 73 basis points on July 4, the most since April 2010.

Portugal Debt

Banco Espirito Santo said it had exposure of 1.18 billion euros ($1.6 billion) to companies of Grupo Espirito Santo and is waiting for the release of that group’s restructuring plan to assess any potential losses. Portugal’s central bank said the lender is protected.

With “disappointments from Europe, you’ve built into the current price structure that Europe’s not doing very well,” said Jim Vogel, head of agency-debt research at FTN Financial in Memphis, Tennessee. “We now need at least a couple of more weeks to make sure Europe’s not going to disappoint further. That will keep the long end of the Treasury curve in a lower range than it would be otherwise.”

Fed officials said their bond-purchase program would end with a final reduction of $15 billion in buying at their October meeting if the economy progresses as they expect, according to minutes of the central bank’s June 17-18 meeting.

Traders see a 70 percent chance the Fed will raise its key rate by September 2015, compared with 57 percent at the end of May, federal fund futures contracts show. The central bank has kept its target for the benchmark fed funds rate in a range of zero to 0.25 percent since December 2008 in an effort to boost economic growth and lower unemployment.

“The market is skeptical that the growth momentum will persist,” Amitabh Arora, an interest-rate strategist in New York at Citigroup Inc., wrote in a note to clients. “Fed rhetoric has managed to persuade the market that this hiking cycle will be even slower and lower than the last one.”

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