Treasuries Advance as U.S. Inflation Persists Below Fed’s Target

Treasuries rose, pushing yields on 30-year bonds to almost the lowest this month, after a report showed that inflation remains below the Federal Reserve’s target even with the economy expanding and adding jobs.

The U.S. sale of $13 billion in inflation-index notes received higher-than-average demand as investors sought a hedge against gains in consumer prices after the Labor Department said its measure excluding food and energy increased the most in five months while the overall cost of living was unchanged. The median forecast in a survey by the Fed Bank of New York of the 22 primary dealers that trade with the central bank was for interest rates to go up in June for the first time since 2006.

“Inflation expectations are still quite low, and it’s hard to see them turning around anytime soon,” said Thomas Simons, a government-debt economist in New York at Jefferies LLC, one of the 22 primary dealers deal with the Fed.

Thirty-year bond yields declined two basis points, or 0.02 percentage point, to 3.06 percent at 5 p.m. New York time, according to Bloomberg Bond Trader data. The yield on the long bond, the security most sensitive to inflation, reached 3.02 percent after touching 3.01 percent on Nov. 17, the lowest since Oct. 30. The price of the 3 percent security maturing in November 2044 increased 14/32, or $4.38 per $1,000 face amount, to 98 30/32.

Ten-year note yields fell two basis points to 2.34 percent after dropping to as low as 2.30 percent.

The volume of Treasuries traded through ICAP Plc, the largest inter-dealer broker of U.S. government debt, rose for a second day, gaining 10 percent to $348 billion. The daily average this year is $332 billion.

TIPS Auction

The yield gap between 10-year Treasuries and comparable Treasury Inflation Protected Securities, a gauge of trader expectations for consumer prices over the life of the debt known as the break-even rate, widened to 1.86 percentage points after closing yesterday at 1.84 percentage points, the narrowest in three years.

The U.S. sold 10-year Treasury Inflation Protected Securities at a yield of 0.497 percent, compared with a forecast of 0.504 percent in a Bloomberg News survey of six primary dealers. The sale was rated a four by five primary dealers on a scale of one through five, with one being a failed auction.

The bid-to-cover ratio, which gauges demand by comparing total bids with the amount offered, was 2.57, versus 2.20 at the last auction of the securities in September, which was the lowest since 2008. The average at the past 10 sales was 2.51.

Central Banks

Indirect bidders, an investor category that includes foreign central banks, bought 62.4 percent of the securities, the most since May, versus an average of 53.7 percent at the past 10 offerings. Direct bidders, non-primary-dealer investors that place their bids directly with the Treasury, purchased 8.1 percent, compared with an average 8.7 percent at the past 10 sales.

Inflation-index notes pay interest at lower rates than nominal Treasuries on a principal amount that’s linked to the Labor Department’s consumer price index.

The consumer-price index rose 1.7 percent in the 12 months ended in October, the same as in September, the Labor Department reported. Economists in a Bloomberg survey projected 1.6 percent. It was unchanged on a month-to-month basis after rising 0.1 percent in September.

The so-called core measure increased 0.2 percent on a month-to-month basis, the most since May, versus economists’ forecast for a 0.1 percent gain that matched September’s figure.

The Treasury announced it will auction $92 billion in fixed-rate notes next week: $28 billion in two-year debt, $35 billion in five-year securities and $29 billion in seven-years. It will also sell $13 billion in two-year floating-rate notes.

Inflation Vigilance

Minutes released yesterday of the Fed’s October meeting said many officials urged vigilance for “evidence of a possible downward shift” in longer-term inflation expectations.

The central bank has kept the benchmark interest-rate target in a range of zero to 0.25 percent since December 2008 to support the economy. It ended a bond-purchase stimulus program at the October meeting, citing improvements in the labor market. Employers added more than 200,000 jobs in October for the ninth month this year.

Policy makers reiterated last month they’ll keep interest rates low for a “considerable time” after concluding the bond purchases. The timing will depend on progress toward their twin goals of maximum employment and 2 percent inflation, they said.

The Fed’s survey of primary dealers, taken Oct. 16-20, showed the firms saw a 64 percent chance policy makers will alter the central bank’s forward guidance by year-end.

Rate Outlook

“Most would say the earliest the Fed might tighten is mid-2015,” said David Coard, head of fixed-income trading in New York at Williams Capital Group, a brokerage for institutional investors. He said he expects rates may go up by June. “If we continue to get solid data, and warnings that inflation could be picking up, particularly with respect to labor costs, we’ll probably see the markets get ahead of the Fed.”

Treasuries pared gains after data showed purchases of previously owned U.S. homes climbed in October to a one-year high. A gauge of U.S. leading indicators widened last month, while a Fed manufacturing index for the Philadelphia region jumped this month.

“The U.S. seems to be the island of prosperity that everyone is talking about,” said Ira Jersey, an interest-rate strategist at the primary dealer Credit Suisse Group AG in New York. “People are less pessimistic than they were after seeing the data from Europe and China.”

Treasuries climbed earlier after data showed weakness in manufacturing in Europe and Asia. A gauge of factories and services activity in the euro area unexpectedly fell to 51.4 in November, the lowest in 16 months, according to London-based Markit Economics. A reading above 50 indicates expansion.

A factory PMI for China fell to 50.0 in November from 50.4 in October, Markit and HSBC Holdings Plc said separately today. The median estimate in a Bloomberg survey was for 50.2.

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