U.S. Debt in Worst Start Since 2003

By Cordell Eddings and Liz Capo McCormick - Jan 21, 2012 5:20 AM GMT+0700

Treasuries are off to their worst start since 2003 on signs the U.S. economy is strengthening and Europe is moving closer to resolving its debt crisis.

Treasury 10-year notes fell for a third day as a U.S. report showed home sales rose for a third month in December, adding to signs including falling claims for jobless benefits that the world’s largest economy is gaining momentum. Greek officials held debt-swap talks for a third day after Spain and France sold bonds at lower yields yesterday.

“The lack of blowups in European sovereign debt have allowed calm to erupt, and that has weighed on Treasuries,” said Guy LeBas, chief fixed-income strategist at Janney Montgomery Scott LLC in Philadelphia, which oversees $12 billion in fixed-income assets. “Home sales are improving, though from very poor levels, which underlies the improving data we’ve had of late,”

The benchmark 10-year yield rose five basis points, or 0.05 percentage point, to 2.03 percent at 5:02 p.m. in New York, according to Bloomberg Bond Trader prices. The 2 percent note due in November 2021 was down 13/32, or per $4.06 per $1,000 face amount, to 99 25/32. The yield increased 16 basis points this week, the most since the five-day period ended Dec. 23.

U.S. government securities lost 0.342 percent this year, the most since a 0.693 percent loss in 2003, according to Bank of America Merrill Lynch Indexes. Treasuries finished 2003 returning 2.25 percent despite the weak start and have posted annual gains every year but one since 2009, when they fell 3.7 percent in 2009. U.S. corporate bonds returned 0.5 percent this year and German bunds fell 0.1 percent, the indexes show.

Widening Spread

The difference between two- and 10-year yields widened four basis points to 1.78 percentage points after touching 1.79 percentage points, the most since Dec. 13. The spread was as narrow as 1.47 percentage points on Oct. 4.

The Citi Macro Risk Index dropped to a five-month low of 0.601 yesterday, showing increased demand for higher-yielding assets.

“Domestic data has been reasonably good and that’s been a catalyst to the selloff in Treasuries,” said Eric Wand, a fixed-income strategist at Lloyds Bank Corporate Markets in London. “Risk sentiment has been generally positive this week, which reduces the safe-haven bid, pushing yields higher.”

Initial jobless claims plunged to 352,000 in the week ended Jan. 14, the lowest level since April 2008, the Labor Department said yesterday. A Federal Reserve report on Jan. 18 showed factory output increased.

Labor ‘Traction’

“There is some significant traction in the labor market,” said Richard Gilhooly, an interest-rate strategist at Toronto- Dominion Bank’s TD Securities Inc. in New York. “There is beginning to be some consistency and some acceleration in the U.S. economic numbers. Once we get through the first quarter, you should get a big spike in Treasury yields.”

Sales of previously owned U.S. homes rose to the highest level since January 2011, with purchases increasing 5 percent to a 4.61 million annual rate, the National Association of Realtors said today in Washington. The pace was less than the 4.65 million median forecast of 75 economists surveyed by Bloomberg News.

Even as core consumer prices are running at almost the Fed’s ideal of about 2 percent, investors are snapping up inflation-protected debt for insurance against a risk that price levels rebound. The U.S. sold a record $15 billion in 10-year Treasury Inflation Protected Securities yesterday at a negative yield for the first time.

Negative Yield

The TIPS were auctioned at a so-called high yield of negative 0.046 percent, compared with a forecast of negative 0.027 percent, the average estimate in a Bloomberg News survey of eight of the Fed’s 21 primary dealers that are required to bid on U.S. debt sales. The last four sales of five-year TIPS were at negative yields.

The World Bank said this week that the U.S. economy will expand 2.2 percent in 2012, while the euro area will contract 0.3 percent.

The 10-year yield will advance to 2.59 percent by year-end, according to a Bloomberg survey of banks and securities companies with the most recent forecasts given the heaviest weightings.

“Weak-but-positive growth should allow rates to grind higher, barring an increase in European stress,” according to the report by Royal Bank of Canada analysts including Michael Cloherty, the head of U.S. rates strategy for RBC Capital Markets LLC in New York.

‘Cover to Sell’

Greece’s government and private creditors convened today for a third session of talks on how to reduce the nation’s debt and avert a collapse of the economy.

“There’s been significant progress,” Hans Humes, president of Greylock Capital Management and a member of the creditor committee negotiating the deal with the government, said in a Bloomberg Television interview today.

“The European situation may be dislocating itself some from the Treasury market,” said Paul Horrmann, a broker in New York at Tradition Asiel Securities Inc., an interdealer broker. “As the complexion gets better in Europe there is less need for the flight-to-quality to trade. If we didn’t have the European situation we would be further north of 2 percent on the 10-year note. We’ve had no new bad news, which has given investors cover to sell Treasuries.”

Yields indicate investors are becoming more willing to lend. The three-month London interbank offered rate for loans in dollars was at 0.561 percent yesterday, headed for a second weekly decline.

The Fed is seeking to keep longer-term borrowing costs capped by selling $400 billion of its short-term Treasuries and reinvesting the proceeds into longer-term government debt in a program traders dubbed Operation Twist.

The central bank bought $2.52 billion of Treasuries due from 2036 to 2041 today as part of the program, according to the New York Fed’s website.

To contact the reporters on this story: Cordell Eddings in New York at ceddings@bloomberg.net; Liz Capo McCormick in New York at emccormick7@bloomberg.net

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