U.S. Yield Curve Flattens as Reports Bolster Speculation on Fed

The Treasury market’s five- to 30-year yield curve approached the flattest level since 2009 after reports suggested the economy is growing with little risk of inflation, allowing the Federal Reserve to proceed with plans to increase borrowing costs next year.

The yield gap between the securities narrowed to as low as 1.41 percentage points after the Thomson Reuters/University of Michigan preliminary sentiment index showed consumer confidence rose and inflation expectations fell. U.S. retail sales rose more than forecast. St. Louis Fed President James Bullard said low inflation isn’t enough to justify keeping rates near zero.

“The inflation expectations index fell pretty significantly,” said Thomas Simons, a government-debt economist in New York at Jefferies LLC, one of the 22 primary dealers that trade with the Fed. “You have this general positive momentum in the economy, but continued signs of disinflation, which is very bond-friendly.”

Five-year note yields declined two basis points, or 0.02 percentage point, to 1.61 percent at 5 p.m. New York time, according to Bloomberg Bond Trader data. They rose earlier to 1.67 percent, the highest since Nov. 7, and increased two basis points on the week. The price of the 1.5 percent debt due October 2019 was up 2/32, or 63 cents per $1,000 face amount, to 99 1/2.

Yields on 30-year bond yields decreased three basis points to 3.05 percent after advancing earlier to 3.09 percent.

The five-, 30-year yield curve reached 1.38 percentage points on Nov. 7, the flattest level since January 2009.

Bets Reversed

Hedge-fund managers and other large speculators bet that futures on long bonds and two-year notes will fall, reversing previous wagers, according to data from the U.S. Commodity Futures Trading Commission.

The number of so-called net-short positions on 30-year bonds was 10,852 as of Nov. 11, the most since August 2013, from a net-long position of 1,193 contracts a week earlier, the data showed.

The speculators had a net-short position of 33,292 contracts on two-years, after being net-long 3,508 contracts a week ago, CFTC data showed.

A measure of volatility was little changed this week after reaching a one-month low Nov. 10. Bank of America Merrill Lynch’s MOVE Index, which measures price swings in Treasuries based on options, was at 67 after touching 66.6 on Nov. 10, the least since Oct. 9. The measure reached a reading of 101 on Oct. 15, the highest since Sept. 10, 2013. The 2014 average is 61.

Volume Declines

The volume of Treasuries traded through ICAP Plc, the largest inter-dealer broker of U.S. government debt, fell 14 percent to $273 billion, compared with a daily average of $332 billion this year. It climbed to $946 billion on Oct. 15, the highest on record.

Consumers in November expected inflation to be 2.6 percent a year from now, down from an estimate of 2.9 percent in October, the Thomson Reuters/University of Michigan preliminary sentiment index showed today. They also foresaw inflation at 2.6 percent five years from now, matching the smallest increase since September 2002, the data showed. The confidence index increased to 89.4, the strongest since July 2007.

Inflation readings using the Fed’s preferred measure of prices, personal consumption expenditures, have held below the Fed’s 2 percent target for more than two years. The index was at 1.4 percent in September.

Bullard, who doesn’t vote on the policy-setting Federal Open Market Committee this year, said global factors, including lower oil prices and economic slumps in Europe and Japan, may be holding down U.S. consumer prices temporarily.

Bullard’s View

“The FOMC has indicated that the policy rate is likely to rise next year, with the exact timing dependent on macroeconomic data in coming quarters,” Bullard said in St. Louis. “While a low inflation rate may suggest a somewhat lower-than-normal policy rate, that effect is not large enough to justify remaining at the zero lower bound.”

The Labor Department will report Nov. 20 that the consumer price index rose 1.6 percent in October from a year earlier, according to the median forecast of 16 economists in a Bloomberg News survey. The pace in September was 1.7 percent.

The Fed has maintained its benchmark interest-rate target at virtually zero since 2008 to support the economy. While policy makers at their October meeting concluded a bond-purchase program designed to hold down long-term borrowing costs and spur growth, they retained a pledge to keep interest rates low for a “considerable time” after the end of the buying.

‘Getting Better’

“As things get better, the Fed can’t keep looking for the dark clouds on the horizon,” said Michael Franzese, senior vice president of fixed-income trading at ED&F Man Capital Markets in New York. “They have to let the economy sink or swim on its own, and it looks like, as they’re pulling back, things are getting better.”

Retail sales increased 0.3 percent in November after a 0.3 percent drop in September, the Commerce Department reported today in Washington. Economists surveyed by Bloomberg projected a 0.2 percent advance. Eleven of 13 major categories showed gains, indicating broad-based growth.

Brent crude oil headed for an eighth weekly decline. It touched $76.76 a barrel, a four-year low, before rising to $79.66.

Bond yields that have changed little since the Fed’s Oct. 29 policy statement indicate bond investors have yet to decide whether the slump in oil prices will do more to stimulate growth and spending.

“We are just not able to sustain a deeper pullback,” said David Ader, head of U.S. government bond strategy at CRT Capital Group LLC in Stamford, Connecticut. “You don’t know which way it will tip when the scales are so balanced.”

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