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Treasuries Drop Fastest Since 2010 as Economy Blocks Fed

Published: August 18, 2012 | 8:44 am
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Treasuries posted their biggest four-week decline since December 2010 as signs economic growth is accelerating dimmed the likelihood the Federal Reserve will initiate another round of asset purchases.

Economic data on the job market, the housing industry and consumer purchasing and sentiment showed signs of faster growth, helping reduce haven demand to push benchmark 10-year Treasury yields to the highest level since May 11. The central bank will release minutes from its Aug. 1 meeting where it declined to initiate a third round of monetary stimulus, a policy known as quantitative easing, or QE. Fed Chairman Ben S. Bernanke will address the Kansas City Fed’s annual conference on monetary policy at Jackson Hole, Wyoming, on Aug. 31.

“The market’s saying there is no QE3,” said Charles Comiskey, head of Treasury trading at Bank of Nova Scotia in New York, one of 21 primary dealers that trade with the Fed. “Rates have backed up significantly. QE3 is off the table.”

The 10-year note yield rose 15 basis points this week, or 0.15 percentage point, to 1.81 percent, according to Bloomberg Bond Trader prices. The 1.625 percent note due in August 2022 dropped 1 13/32 or $14.06 per $1,000 face value to 98 9/32.

Yield Path
The yield on the securities has climbed 35 basis points from 1.46 percent on July 20, the biggest four-week increase since the weeks ended Dec. 24, 2010, when the yield rose 52 basis points. That boost in yields came four weeks after the Fed announced a $600 billion program of purchases of Treasury securities with the goal of increasing inflation expectations.

“Economic activity decelerated somewhat over the first half of this year,” the Federal Open Market Committee said Aug. 1. “The committee will closely monitor incoming information on economic and financial developments and will provide additional accommodation as needed to promote a stronger economic recovery and sustained improvement in labor market conditions in a context of price stability.”

The minutes of the meeting will be released Aug. 22.

So-called convexity-related hedging by holders of mortgage- backed securities may have contributed to declines in Treasuries, according to analysts at Bank of America Corp. Rising Treasury yields help drive mortgage rates higher, triggering hedging from holders of mortgage-backed securities, wrote Priya Misra and Shyam Rajan, interest-rate strategists at Bank of America in New York, in a note to clients today.

Mortgage Hedges
Rising mortgage rates decrease the risk of mortgage refinancing, which increases bond holders’ duration. The hedging spurs demand to pay fixed rates in swaps, driving swap rates higher and swap spreads wider.

Convexity-related hedging may “have been responsible for the last 10 basis points of the selloff,” they wrote.

A selloff paused when 10-year yields climbed as high as 1.86 percent Aug. 16, matching the 200-day moving average, according to data compiled by Bloomberg. The 10-day relative- strength index, a gauge of momentum, for the 10-year note, was 72.4 yesterday, compared with 47.5 on Aug. 2. A level below 30 or above 70 suggests the yield may change direction. The index reached 28.5 on July 24, the day before the 10-year yields fell to a record low 1.379 percent.

“We seem to be trying to get our footing in this 1.80 percent to 1.85 percent area,” said John Briggs, a U.S. government-bond strategist at Royal Bank of Scotland Group Plc’s RBS Securities unit in Stamford, Connecticut, a primary dealer. “We could generate a near-term rally just because of the technicals.”

Futures Positions
Hedge-fund managers and other large speculators reversed from a net-short position to a net-long position in 10-year note futures for the week ending Aug. 14, according to U.S. Commodity Futures Trading Commission data.

Speculative long positions, or bets prices will rise, outnumbered short positions by 32,336 contracts on the Chicago Board of Trade. Last week, traders were net-short 14,595 contracts.

U.S. government securities have handed investors a 1.6 percent loss this month as of yesterday, according to Bank of America Merrill Lynch indexes, as economic data exceeded forecasts and the European debt crisis eased. An index of sovereign bonds around the world slid 0.7 percent, reflecting waning demand for the relative safety of debt.

The MSCI All-Country World Index (MXWD) of stocks returned 3.2 percent including reinvested dividends, according to data compiled by Bloomberg.

Economic Data
The index of U.S. leading economic indicators climbed more than forecast in July, a sign of sustained expansion in the world’s largest economy. The Thomson Reuters/University of Michigan preliminary August index of consumer sentiment increased to 73.6, the highest level since May, from 72.3 the prior month.

U.S. retail sales rose 0.8 percent in July, a report on Aug. 14 showed, above the median estimate of economists in a Bloomberg survey. A separate report on Aug. 3 showed the U.S. added 163,000 jobs last month, more than the 100,000 projected by analysts.

Building permits, a proxy for future construction, rose to an 812,000 pace, the most since August 2008. New-home starts fell 1.1 percent to a 746,000 annual rate from June’s 754,000 pace, Commerce Department figures showed Aug. 16 in Washington. The median estimate of 79 economists surveyed by Bloomberg News called for 756,000.

Jobless claims climbed by 2,000 to 366,000 in the week ended Aug. 11, Labor Department figures showed Aug. 16 in Washington. The four-week moving average fell to 373,400, the lowest since July 2008.

Budget Update
The U.S. government’s deficit narrowed as spending dropped by 11.9 percent from a year earlier and some payments were accelerated to the previous month for calendar-related reasons. The deficit through July for the 2012 fiscal year, which ends Sept. 30, is $973.8 billion compared with $1.1 trillion at this point last year and the lowest for July since 2008.

Even as the economy shows signs of improvement, the U.S. “will be on downgrade watch again as the end of the year comes in,” said Michael Cloherty, head of U.S. interest-rate strategy at Royal Bank of Canada’s RBC Capital Markets unit in New York, a primary dealer, in an interview on Bloomberg Radio with Tom Keene.

Efforts to support the economy by scaling back budget cuts enacted as part of August 2011 agreement to increase the debt ceiling may lead to an additional reduction to the U.S. credit rating, Cloherty said. “It’s going to be very difficult to avoid the effects of the fiscal cliff.”


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