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Fed Policy Stance Pushes Treasury Yields Down

Sunday, 26 September 2010 01:59 PM

Treasuries rose Friday, pushing the yield on the 10-year note down the most in six weeks, as the Federal Reserve signaled its willingness to ease monetary policy further to boost the economy and return inflation to its target.

The two-year note yield touched a record low this week on speculation the central bank will increase purchases of U.S. debt to keep interest rates low. The Treasury announced that it will auction $100 billion in 2-, 5- and 7-year notes next week, compared with $102 billion in August.

“This week has been all about the Fed, which has lowered the bar for additional quantitative easing and is considering it, putting inflation squarely in the crosshairs and giving a boost to Treasuries,” William O’Donnell, U.S. government bond strategist in Stamford, Connecticut, at Royal Bank of Scotland Plc, one of the 18 primary dealers that trade with the Fed.

The yield on the benchmark 10-year note fell 13 basis points, or 0.13 percentage point, to 2.61 percent, according to BGCantor Market Data. The price of the 2.625 percent security maturing in August 2020 increased 1 1/8, or $11.25 per $1,000 face amount, to 100 1/8.

The government reduced two- and five-year note offerings next week compared with the August sale by $1 billion to $36 billion and $35 billion, respectively, while keeping the offering of seven-year securities at $29 billion.

The drop in the 10-year yield was the biggest since the five days ended Aug. 13, when it slid 15 basis points. The two- year note yield decreased 2 basis points to 0.44 percent after touching the record low of 0.41 percent on Sept. 22.

‘Bull Trend’

“There is an underlying bid in the market as the bull trend in Treasuries remains intact,” said Martin Mitchell, head government bond trader in Baltimore at Stifel Nicolaus & Co., a brokerage firm. “The Fed has tipped their hand that they are likely to initiate a larger-scale asset-purchase program in the future. If the Fed becomes a larger buyer, the Treasury market can only go higher.”

The Fed said in its statement on Sept. 21 that it’s prepared “to provide additional accommodation if needed to support economic recovery and to return inflation, over time, to levels consistent with its mandate.”

Consumer prices excluding food and energy increased in August for a fifth month at an annual rate of 0.9 percent, matching the slowest year-over-year rate of gains since 1966, the Labor Department said Sept. 17.

Break-Even Rate

The difference between yields on 10-year notes and Treasury Inflation Protected Securities, a gauge of trader expectations for consumer prices over the life of the maturity known as the break-even rate, was 1.84 percentage points, compared with the five-year average of 2.11 percentage points.

Economic growth slowed to a 1.6 percent annual pace in the second quarter, from 3.7 percent from January through March, the Commerce Department said Aug. 27. The unemployment rate increased to 9.6 percent from 9.5 percent, the Labor Department reported Sept. 3.

The central bank retained its stance from its Aug. 10 meeting of keeping its portfolio of securities stable at about $2 trillion to keep money from draining out of the financial system. The Fed bought $3.89 billion of Treasuries yesterday maturing from September 2014 to August 2016, increasing the amount it has bought since Aug. 17 to $34.062 billion.

The Fed completed a program of quantitative easing in March, purchasing $1.25 trillion of agency mortgage-backed securities and about $175 billion of agency debt. The central bank was the biggest buyer of Treasuries when it bought $300 billion of U.S. debt in 2009.

Citigroup’s View

Another round of asset purchases by the central bank may exceed the amount it bought in 2009, according to Citigroup Inc., a primary dealer.

“Should quantitative easing become necessary, we expect that the sizing will be approximately $100 billion per month in U.S. Treasuries only, with an initial window of two to three quarters,” Brett Rose, a strategist at Citigroup in New York, wrote in an e-mailed report this week.

Yields on five-year Treasury Inflation Protected Securities turned negative after the Fed said inflation is running below levels that reflect a healthy economy.

As yields on conventional shorter maturities have plunged, investors have been willing to buy TIPS with negative yields betting that return from the inflation adjustment will exceed the interest the fixed-rate notes pay. TIPS pay interest on a principal amount that rises with consumer prices.

The five-year inflation-protected note yield dropped 16 basis points to negative 0.029 percent. The price of the 0.5 percent security maturing in April 2015 gained 23/32, or $7.19 per $1,000 face amount, to 102 13/32.

The TIPS yield last turned negative on Aug. 6, four days before the central bank said it would keep its bond holdings level by resuming the purchase of U.S. debt.

Yields on TIPS maturing in July 2012 have been negative since July 20 as yields on conventional two-year Treasuries dropped to record lows well below the annual rate of inflation.

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Treasuries rose Friday, pushing the yield on the 10-year note down the most in six weeks, as the Federal Reserve signaled its willingness to ease monetary policy further to boost the economy and return inflation to its target.The two-year note yield touched a record low...
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Sunday, 26 September 2010 01:59 PM
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