Treasuries End Longest Skid in a Year on U.S. Production

Treasuries gained for the first time in eight days, ending the longest skid in more than a year, as industrial production in the U.S. unexpectedly declined in August for the first time in seven months.

Treasury 10-year yields reached the highest since July earlier amid speculation the Federal Reserve will delete reference to interest rates staying low for a “considerable time” when it meets this week. The odds the central bank will increase its benchmark rate by July 2015 have risen to 58 percent from 51 percent at the end of August, federal fund futures show.

“There was a little pop in the market when the number came out,” Thomas Simons, a government-debt economist in New York at Jefferies Group LLC, one of 22 primary dealers that trade with the Fed, said of the industrial-production report. “The Fed is everything at this point. We’re looking at the dots, and if the ‘considerable time’ language is taken out.”

The yield on Treasury 10-year securities fell two basis points, or 0.02 percentage point, to 2.59 percent as of 5 p.m. New York time, according to Bloomberg Bond Trader data. The price of the 2.375 percent note due in August 2024 rose 6/32, or $1.88 per $1,000 face value, to 98 1/8. The last seven-day slide ended June 25, 2013.

The yield touched 2.62 percent, the highest since July 7, after climbing 15 basis points last week, the biggest five-day increase since the period ended Aug. 16, 2013.

Fed ‘Tightening’

“Ultimately, the Fed will have to work toward tightening and away from the super-accommodative stance we’ve had,” said Brian Edmonds, the head of interest-rates trading in New York at primary dealer Cantor Fitzgerald LP. “We’ve backed off the lowest yields seen, so we should have some kind of buffer in there. That should be supportive of the back end of the curve.”

The five-year yield touched 1.83 percent, the highest level since Sept. 6, 2013, before dropping to 1.79 percent. It gained 12 basis points last week.

The five-year note “seems to be where people are pointing to value right now,” Edmonds said.

Treasuries have returned 3 percent this year after losing 3.4 percent in 2013, according to a Bank of America Merrill Lynch Index. Treasuries have lost investors 1.24 percent this month.

FOMC Meeting

The Federal Open Market Committee begins a two-day meeting in Washington tomorrow amid comments from officials including Boston Fed President Eric Rosengren that it’s time to consider dropping a pledge to keep rates low for a “considerable time” after the completion of the central bank’s bond-purchase program.

The Fed reduced its monthly buying to $25 billion in August from $35 billion in July, and it is on track to end the purchases this year. Its assets have ballooned to $4.42 trillion from less than $1 trillion in 2008.

“The focus is on the Fed and expectations for that -- I’m expecting some type of adjustment” of forward guidance, said Thomas Tucci, managing director and head of Treasury trading in New York at CIBC World Markets Corp. “We’re getting closer to the end of tapering so we’re redistributing” in the long end.

The range on the 10-year yield will be 2.50 to 2.75 percent through year-end, said Tucci. It will end the year at 2.79 percent, according to the median forecast of 71 economists and strategists in a Bloomberg survey.

Connecting Dots

Options traders are betting that Fed officials’ estimates of where the policy rate will be at the end of 2017, displayed as dots on a chart, will be significantly higher than the 2.73 percent rate currently signaled by the December 2017 contracts.

Traders in options appear to be “convinced that the FOMC will present a December 2017 ‘dot’ around 3.25 percent or even higher, which is well above where the market now has it priced,” said Stan Jonas, former managing partner of Axiom Management Partners in New York.

U.S. government debt rose today as output at factories, mines and utilities fell 0.1 percent after a 0.2 percent gain the prior month that was smaller than previously reported, figures from the Fed showed today in Washington. The median forecast in a Bloomberg survey of 79 economists called for a 0.3 percent rise. Automakers scaled back following the biggest surge in almost five years.

That helped narrow the difference between yields on two-year notes and 10-year debt to 2.04 percentage points after earlier touching 2.06 percentage points, the most since Aug. 1. A steepening yield curve suggests investors are demanding higher compensation against the risk of inflation as economic growth improves.

Inflation Expectations

While more than $3 trillion of debt purchases by the Fed since 2008 helped the U.S. recover from its worst recession in seven decades, bond-market indicators for inflation expectations have fallen this quarter. A government report this week is forecast to show inflation slowed in August.

Consumer prices rose 1.9 percent in August from the year before, versus 2 percent in July, based on a Bloomberg News survey of economists before the Sept. 17 report.

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, has fallen to 2.13 percentage points from 2.30 as recently as July. The five-year average is 2.20.

The U.S. is scheduled to sell $13 billion in 10-year inflation-indexed securities on Sept. 18.

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