Treasury Notes Suffer Biggest Rout Since May on ECB Spillover

  • U.S.-German two-year gap declines from nine-year high
  • Yellen remarks support expectations for December liftoff

Treasuries plummeted, driving up 10-year note yields by the most since May, after European Central Bank policy makers delivered additional stimulus measures that fell short of some forecasts.

Even with a U.S. employment report looming and the first Federal Reserve interest-rate increase since 2006 potentially less than two weeks away, the trigger for Thursday’s losses came from Europe. Government debt tumbled after the ECB’s announcement that it wouldn’t expand monthly asset purchases, even though it committed to extending quantitative easing by six months.

After touching a nine-year high on speculation that the Fed is poised to raise rates, the extra yield that U.S. two-year notes offer over their German counterparts shrank by the most since mid-September, to 1.26 percentage points.

"It’s a painful day for the bond market," said Charles Comiskey, head of Treasuries trading in New York at Bank of Nova Scotia, one of 22 primary dealers that trade with the Fed. "A lot of things came to a head,” starting with the events in Europe.

The benchmark U.S. 10-year note yield rose about 13 basis points, or 0.13 percentage point, to 2.31 percent as of 5 p.m. New York time, according to Bloomberg Bond Trader data. The price on the 2.25 percent note due in November 2025 sank about 1 6/32, or $11.88 per $1,000 face amount, to 99 13/32.

Yellen’s Message

In testimony before a congressional committee Thursday, Fed Chair Janet Yellen signaled the conditions necessary for an interest-rate increase have been met and that she hopes to tighten monetary policy slowly after liftoff. Government figures set for release Friday will probably show that U.S. employers added at least 200,000 jobs for the second straight month in November, according to the median forecast in a Bloomberg survey.

Futures indicate a 74 percent probability of a Fed rate increase by year-end, according to data compiled by Bloomberg. The calculations are based on the assumption the effective fed funds rate will average 0.375 percent after liftoff, compared with the current range of zero to 0.25 percent, where it’s been since 2008.

U.S. two-year yields reached 0.99 percent, the highest since May 2010, as traders prepared for a Fed move. Yet yields on similar-maturity German bunds rose more, collapsing the spread between the two to the smallest in two weeks.

Treasury yields “are being driven higher by the selloff in European fixed income," said Gennadiy Goldberg, a U.S. rates strategist in New York for TD Securities, a primary dealer. ECB President Mario Draghi is “known for overdelivering. That’s not the case anymore. He’s underdelivered."

Long Losses

Longer-dated Treasuries absorbed the brunt of the losses as the ECB’s decision caused the dollar to weaken the most since 2009 against the euro, raising the specter that U.S. inflation may quicken. Lengthier maturities are more vulnerable to accelerating inflation, which erodes the value of the debt’s fixed payments.

The yield difference between two- and 30-year maturities widened by the most since 2011, and a bond-market measure of inflation expectations rose by the most since October.

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