Treasury 2-Year Yields Touch 2011 Highs on U.S. Growth Surge

Treasuries fell, pushing two-year note yields to the highest in almost four years, after a report showed the U.S. economy grew at the fastest rate in a decade, bolstering the case for the Federal Reserve to raise interest rates next year.

The benchmark 10-year note yield rose as a report showed the world’s largest economy expanded at an annualized rate of 5 percent, compared with a forecast of 4.3 percent in a Bloomberg News survey. A separate report showed consumer spending rose more than forecast last month, supporting the growth outlook. The U.S. is scheduled to sell $35 billion of five-year notes today.

“It helps the Fed for their lift-off to start in the next six months,” said Justin Lederer, an interest rate strategist at Cantor Fitzgerald LP in New York, one of 22 primary dealers that trade with the Fed. “GDP was strong. Personal consumption was excellent. Yields are heading a little bit higher on this.”

The two-year note yield rose two basis points, or 0.02 percentage point to 0.74 percent at 11:40 a.m. New York time, according to Bloomberg Bond Trader data. The price of the 0.5 percent note due in December 2016 was 99 25/32. The yield reached the highest level since April 2011.

Ten-year note yields added four basis points to 2.20 percent.

Bond Returns

Treasuries have returned 6.1 percent this year through the end of last week, according to the Bloomberg U.S. Treasury Bond Index, set for the biggest annual gain since 2011. They lost 3.4 percent last year.

The chances of a Fed interest-rate increase by its September 2015 meeting increased to 68 percent from 53 percent on Dec. 16, the day before the Federal Open Market Committee issued its policy statement, according to futures data. The central bank has held its target for the federal funds rate at zero to 0.25 percent since December 2008.

Gross domestic product growth was up from a previously estimated 3.9 percent, revised figures from the Commerce Department showed. Consumer spending is poised to charge into 2015 as more employment and lower gasoline prices boost household confidence and buying power.

Household purchases climbed 0.6 percent, the most in three months, after a 0.3 percent October gain that was larger than previously estimated, Commerce Department figures showed. The improving outlook for household spending, which accounts for about 70 percent of the economy, will spur growth this quarter and into 2015 even as the rest of the world cools.

Economic Reading

Separate reports showed other sectors lagging behind.

Durable goods orders unexpectedly dropped 0.7 percent in November, compared with an estimate of a 3 percent increase. Sales of new houses unexpectedly dropped in November to a 438,000 annualized rate, the fewest since July, according to Commerce Department data.

Central bank officials on Dec. 17 said they would be “patient” on the timing of the first interest-rate increase and expect inflation to rise gradually toward their goal.

The inflation gauge preferred by Fed policy makers hasn’t been above their 2 percent goal since March 2012.

The core price measure, which excludes food and fuel, was unchanged from the prior month and was up 1.4 percent from November 2013. It was the first time the gauge failed to increase on a monthly basis since April 2013.

Inflation Watch

“The constraining factor in 2015 is likely to be low inflation, rather than slow domestic growth,” said Guy LeBas, chief fixed-income strategist at Janney Montgomery Scott LLC in Philadelphia, which manages $61 billion in assets.

The U.S. 10-year break-even rate, a gauge of expectations of consumer prices derived from the difference in yield between conventional Treasuries and inflation-protected securities, was little changed at 171 basis points after shrinking to 158 basis points on Dec. 16, the narrowest since September 2010.

The five-year notes due to be sold today yielded 1.705 percent in pre-auction trading. That would be the highest level at the monthly sales since September.

The Treasury sold $13 billion of two-year floating rate notes at a yield of 0.11 percent, higher than the 0.068 percent reported last month. The bid-to-cover ratio, which gauges demand by comparing the number of bids to the amount of securities sold, fell to 2.90 from 4 at the previous sale.

The U.S. sold $27 billion of two-year notes yesterday at an average yield of 0.703 percent, the most since March 2011. The Treasury is due to sell $29 billion of seven-year debt tomorrow.

The Treasury market will close Dec. 25 in observance of the Christmas holiday, according to the Securities Industry and Financial Markets Association’s website. The group recommends an early close at 2 p.m. New York time on Dec. 24.

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