Treasuries Rally as Refuge Appeal Outweighs Employment Recovery

Jul 08, 2014 5:14 pm ET

July 8 (Bloomberg) -- Treasuries gained, with the yield on 10-year notes posting the biggest two-day drop since May, as traders bet the declines after a stronger-than-forecast employment report were overdone as the pace of the recovery remains uneven.

The U.S. sold $27 billion of three-year notes as the highest auction yield since May 2011 attracted investors. The 30-year bond yield fell the most in more than a month as Treasuries investors decreased wagers the prices of securities would drop, according to a survey by JPMorgan Chase & Co. Federal Reserve policy makers have pledged to keep interest rates at almost zero for “a considerable time” after the central bank completes its bond-buying stimulus.

“Treasuries are not cheap, but because of the lack of high quality assets they are still in demand,” said Stanley Sun, a New York-based strategist at Nomura Holdings Inc., a primary dealer, said in a telephone interview. “Buyers are waiting for any dip in prices. Given the state of the economy and the lack of safe assets the buying will continue until there is some fundamental change in the landscape.”

Benchmark 10-year note yields fell six basis points, or 0.06 percentage point, to 2.56 percent at 4:59 p.m. New York time, according to Bloomberg Bond Trader data. The price of the 2.5 percent note due in May 2024 added 15/32, or $4.69 per $1,000 face amount, to 99 1/2. The yield dropped eight basis points during the past two days in the biggest drop since May 28.

Thirty-year bonds gained more than one point, rising the most since May 28 as the yield fell six basis points to 3.37 percent.

Less Bearish

The proportion of net shorts or bets the price of the securities will decrease, was 25 percentage points, according to the JPMorgan survey of the week ending yesterday. The figure compares with a net short of 27 percentage points in the previous week. The percent of outright shorts, or bets the securities will drop in value, remained steady at 38 percent. The percent of outright longs rose to 13 percent as of yesterday from 11 percent.

Investors cut neutral bets to 49 percent, from 51 percent the previous week, the survey reported.

Current three-year yields declined two basis points to 0.95 percent. The note auction drew a yield of 0.992 percent, compared with a forecast of 0.998 percent in a Bloomberg News survey of nine of the Federal Reserve’s 22 primary dealers.

The bid-to-cover ratio, which gauges demand by comparing total bids with the amount of securities offered, was 3.38, versus an average of 3.34 for the past 10 sales.

Auction Demand

“The auction was reasonably strong,” said Ian Lyngen, a government bond strategist at CRT Capital Group LLC in Stamford, Connecticut. “The securities sold at relatively higher yields and it brought buyers in who were on the sidelines. The front end has been underperforming, and it’s catching up slowly.”

Indirect bidders, an investor class that includes foreign central banks, purchased 38.2 percent of the notes, compared with an average of 32.1 percent at the past 10 sales.

Direct bidders, non-primary-dealer investors that place their bids directly with the Treasury, purchased 12.7 percent of the notes, versus an average of 19.4 percent at the past 10 auctions.

Three-year notes have returned 0.4 percent this year, compared with a gain of 2.6 percent by the broader Treasuries market, according to Bank of America Merrill Lynch indexes. The three-year securities lost 0.1 percent in 2013, while Treasuries overall fell 3.4 percent.

More Sales

Today’s offering is the first of three note and bond auctions this week totaling $61 billion. The government will sell $21 billion in 10-year debt tomorrow and $13 billion in 30- year securities on July 10.

Long-term Treasuries are poised to rally as the skew in option volatility reached the lowest since 2011, signaling wagers for higher yields have become overdone, according to Bank of America Corp.

Positioning for higher Treasury yields amid signs of an improving labor market and rising inflation has spurred hedging of those bets through purchases of options that profit if rates fall, causing the so-called skew to fall, Bank of America analysts said. Short positions, or bets yields will rise, have held even as Federal Reserve policy makers said after its June 18 meeting that it will keep the benchmark interest rate at almost zero for a “considerable time” after its bond-buying program ends, likely later this year.

“The sharp flattening of the skew over the last six months may signal a build-up of, and now crowded, short positions,” said Ruslan Bikbov, a fixed-income strategist in New York at Bank of America, said in a telephone interview. “Investors establishing these core short positions are hedging those bets with options. And history shows a decline in the skew has been a significant predictor of lower yields.”

Fed Views

Investors are adding to bets the Fed will raise borrowing costs next year after the government reported last week that U.S. employers added 288,000 workers in June, compared with the 215,000 projected by a Bloomberg News survey of economists.

Goldman Sachs Group Inc. and JPMorgan Chase & Co. are among banks to have brought forward in the past week their estimated dates for the Fed’s first rate increase. The central bank is scheduled to publish the minutes of its June 17-18 meeting tomorrow.

Traders see a 77 percent chance that officials will raise the key rate by September 2015, fed funds futures contracts show. The central bank has kept the benchmark fed funds rate in a range of zero to 0.25 percent since December 2008.

“We have a recovering economy and we’re closer to rate hikes, and it’s moving the short end a bit,” said Thomas Roth, senior Treasury trader in New York at Mitsubishi UFJ Securities USA Inc. “There’s a reach for yield.”

--With assistance from David Goodman in London and Liz Capo McCormick in New York.