Treasury Yields at Month High as Fed Eases Contagion Concern

By Cordell Eddings and Daniel Kruger - Dec 3, 2011 12:00 PM GMT+0700

Treasuries fell, pushing 10-year yields to the highest level in more than a month, as emergency dollar funding for European banks arranged by the Federal Reserve reduced concern the region’s debt crisis will worsen.

Ten-year note yields rose for the first time in three weeks as a report yesterday showed job gains in the U.S. picked up last month and the unemployment rate unexpectedly fell to the lowest level since March 2009. Treasuries retained their claim as the world’s favored refuge from turmoil, with U.S. bond yields dropping below those on German debt for the first time since May 2009 before a summit of European leaders on Dec. 9.

“The momentum in the market has gotten better because we haven’t seen the end of the world and central banks are signaling they get it,” said George Goncalves, head of interest rate strategy at Nomura Holdings Inc., one of 21 primary dealers that trade directly with the Fed. “Still, we are at the mercy of a lack of conviction in the market as there is a large sense of skepticism about policy makers coming through in the weeks ahead.”

The benchmark 10-year note yield rose seven basis points, or 0.07 percentage point, to 2.03 percent from 1.96 percent Nov. 25, according to Bloomberg Bond Trader prices. The 2 percent note due November 2021 dropped 20/32, or $6.25 per $1,000 face amount, to 99 22/32. The yield reached as high as 2.16 percent, the most since Oct. 31.

Bond Yields

The yield on the 30-year bond rose 11 basis points to 3.02 percent. The yield traded as low as 2.92 percent on Nov. 29 while German 30-year yield reached as high as 2.96 percent.

Treasuries have returned 8.5 percent in 2011, set for the best annual return since a 14 percent gain in 2008, Bank of America Merrill Lynch index data show.

The U.S. 10-year yield traded in a 28-basis-point range during November, with a high of 2.15 percent and a low of 1.87 percent. That compares with a 70-basis-point range the month before.

“The European sovereign-debt issue is still the biggest issue and that will continue to give Treasuries support,” Larry Milstein, managing director in New York of government and agency debt trading at R.W. Pressprich & Co., a fixed-income broker and dealer for institutional investors, said on Nov. 29.

Bet Swings

Hedge-fund managers and other large speculators reversed from a net-short position to a net-long position in 10-year note futures in the week ending Nov. 29, according to U.S. Commodity Futures Trading Commission data.

Speculative long positions, or bets prices will increase, outnumbered short positions by 17,301 contracts on the Chicago Board of Trade. Last week, traders were net-short 15,291 contracts.

The Fed said it was joined in the swap-rate cut by the Bank of Canada, Bank of England, Bank of Japan, European Central Bank and the Swiss National Bank. The dollar funding rate interest rate has been reduced to the dollar overnight index swap rate plus 50 basis points, or half a percentage point, from 100 basis points, and the program was extended to Feb. 1, 2013, the Fed said in a statement in Washington.

The central banks acted after the cost for European banks to fund in dollars rose to the highest levels in three years as concern about a possible breakup of the euro area increased after leaders said they’d failed to boost the region’s bailout fund as much as planned.

Stress Measures

The two-year swap spread, an indicator of risk in the financial system, rose two basis points to 45 basis points yesterday. The spread, which equals the difference between two- year swap rates and comparable maturity Treasury yields, fell as low as 39 basis points on Nov. 30.

The U.S. unemployment rate, derived from a survey of households, was forecast to hold at 9 percent in November. The decrease in the jobless rate reflected a 278,000 gain in employment at the same time 315,000 Americans left the labor force. Labor Department figures showed yesterday in Washington.

Payrolls climbed 120,000, after a revised 100,000 increase in October, with more than half the hiring coming from retailers and temporary-help agencies, The median estimate in a Bloomberg News survey called for a 125,000 gain.

Economic Direction

“It’s a step in the right direction,” said Richard Schlanger, who helps invest $20 billion in fixed-income securities as vice president at Pioneer Investments in Boston. “However, Europe is dominating the headlines right now, and we’re going to have to wait and see how that plays out.”

Pacific Investment Management Co.’s Bill Gross said U.S. employment growth won’t prevent the Fed from signaling that borrowing rates will remain lower longer than policy makers have already indicated.

The central bank will keep the target rate for overnight loans at current levels for as long as four years, up from the through the middle of 2013 period outlined, Gross, manager of the world’s biggest bond fund, said in a radio interview yesterday on “Bloomberg Surveillance” with Tom Keene and Ken Prewitt.

German Chancellor Angela Merkel likened solving the debt crisis to a marathon in a speech yesterday as she rejected joint euro-area bonds and central-bank action while pushing for closer economic ties among euro nations allied to tougher enforcement of budget rules to counter the debt crisis now in its third year. Merkel said she will consult with French President Nicolas Sarkozy on Dec. 5 to coordinate their approach to next week’s summit.

IMF Plan

A European proposal to channel central-bank loans through the International Monetary Fund may deliver as much as 200 billion euros ($270 billion) to fight the debt crisis, two people familiar with the negotiations said.

“Europe is too important for anything else to have a huge impact as the events there are still driving the market,” said Gary Pollack, head of fixed-income trading at Deutsche Bank AG’s Private Wealth Management unit in New York, which manages $12 billion in bonds. “Until we see something closer to resolution from Europe the market will be transfixed by events over there.”

The 10-year yield will rise to 2.20 percent by year-end, according to a Bloomberg News survey of financial companies, with the most recent forecasts given the heaviest weightings. The yield will reach 2.25 percent by the end of March 2012, the surveys show.

To contact the reporters on this story: Cordell Eddings in New York at ceddings@bloomberg.net; Daniel Kruger in New York at dkruger1@bloomberg.net

To contact the editor responsible for this story: Dave Liedtka at dliedtka@bloomberg.net