Treasury yield curve narrowest since September amid Fed wagers

Bloomberg NewsDecember 10, 2013 

NEW YORK -- The gap between yields on 10- and 30- year Treasuries was at almost the narrowest level in 10 weeks on speculation inflation will remain in check as the Federal Reserve begins to slow bond purchases.

Treasury 10-year note yields traded in the smallest range in almost a week as St. Louis Fed President James Bullard said any reduction in the Fed's $85 billion in monthly asset buy

ing should be modest Dallas Fed President Richard Fisher said tapering needs to start soon.

"There is a very singular focus in the market on the Federal Reserve and their balance sheet, and the Fed hasn't done anything to change their message," said Guy LeBas, chief fixed- income strategist at Janney Montgomery Scott in Philadelphia, which oversees $11 billion in fixed income assets. "Until they do, we will stay in this narrow range, with yield rises contained."

The benchmark 10-year note yield was little changed at 2.85 percent at 4:31 p.m. in New York, according to Bloomberg Bond Trader data. It traded between 2.83 percent and 2.86 percent, the narrowest since Dec. 3. The price of the 2.75 percent note due in November 2023 added 2/32, or 63 cents per $1,000 face amount, to 99 5/32. The 30-year bond yield declined two basis points to 3.87 percent.

The spread between 10- and 30-year Treasuries was little changed after ending last week at 1.03 percentage points, the narrowest on a closing basis since Sept. 24.

Ten-year note yields traded "on special" in the market for U.S. repurchase agreements, or repos, in New York before the Treasury auctions $21 billion of the securities on Wednesday. The yields closed on Monday at negative 1.7 percent in the repo market as investors were willing to pay to borrow the securities overnight. Typically, lenders of cash receive interest on those loans, represented by a positive repo rate.

The U.S. will auction $30 billion of three-year notes on Tuesday and $13 billion of 30-year bonds on Thursday.

The difference in yield between U.S. 10-year notes and comparable Treasury Inflation Protected Securities, a measure of trader expectations for rises in consumer prices over the life of the debt called the break-even rate, was 2.12 percentage points, almost the lowest since Sept. 13. It reached a high for the year on a closing basis of 2.59 percent in February.

"If there was a more material inflation risk, we would expect the curve to steepen out," said Ian Lyngen, a government-bond strategist at CRT Capital Group in Stamford, Conn. "As inflation numbers remain benign, we are open to the notion that 10s and 30s can flatten further."

A Commerce Department report on Friday showed the price index tied to spending, a measure of inflation followed by Fed policy makers, increased 0.7 percent in October from a year earlier, the least since October 2009.

The extra yield Treasury 10-year notes offer over the U.S. inflation rate was about 1.89 percentage points. The real yield climbed to 1.91 percentage points last week, the highest since February 2011, according to data compiled by Bloomberg based on closing prices.

Ten-year notes lost 7 percent this year through last week, versus a 15 percent decline for 30-year bonds, according to Bank of America Merrill Lynch indexes, as investors in both maturities prepared for the Fed to taper bond purchases.

U.S. employers added more workers than economists forecast in November, increasing payrolls by 203,000 jobs, and the jobless rate dropped to a five-year low of 7 percent, the Labor Department said on Friday.

Mohamed El-Erian, chief executive officer of Pacific Investment Management, said world economic growth will pick up next year, paced by improvements in the U.S. and the euro area. The global economy will probably expand 2.5 percent to 3 percent, up from 2.3 percent in 2013, he said. U.S. growth will accelerate to 2.25 percent to 2.75 percent, from 1.8 percent, while the euro region's economy will expand by 0.25 percent to 0.75 percent, after contracting 0.4 percent this year, El-Erian said in an interview.

It's virtually certain the Fed will begin moderating its asset purchases by the end of March, with a 50 percent chance of a move next week, Newport Beach, Calif.-based El-Erian said. The central bank is likely to couple any tapering announcement with a cut in the interest rate it pays on banks' excess reserves and a strengthened commitment to keep monetary policy easy for an extended period. The Fed has held the benchmark interest rate at zero to 0.25 percent since 2008.

Bullard said the odds of tapering bond purchases have risen along with gains in the labor market. Any reduction should be small because inflation is low, he said on Monday in St. Louis.

"A small taper might recognize labor-market improvement while still providing the committee the opportunity to carefully monitor inflation during the first half of 2014," said Bullard, a stimulus supporter who votes on policy this year. "Should inflation not return toward target, the committee could pause tapering at subsequent meetings."

Fisher said in a speech in Chicago that tapering needs to begin "at the earliest opportunity" because its costs will exceed its benefits. It should be done under a "clearly articulated, well-defined calendar," said Fisher, who has opposed additional stimulus. He votes on policy next year.

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