Volatility at 2007 low means Treasuries steady into election

May 7 (Bloomberg) -- The collapse in price swings of U.S. government debt to a four-year low shows increasing investor confidence that yields will stay at about record lows amid growing competition for a dwindling supply of the safest assets.

Rates may stay steady beyond June, when the Federal Reserve finishes swapping $400 billion of short-term debt for longer- term securities in a program known as Operation Twist, based on a measure of volatility in three-month options for U.S. 10-year interest-rate swaps. The so-called 3m10y swaption rate is about the lowest since June 2007, when the housing bubble burst.

While yields on Treasury due in 10 years or less are below the pace of inflation, demand is at record highs as reports on jobs signal that the recovery may not be as robust as forecast and as Europe’s debt crisis flares again. The International Monetary Fund now says the amount of global assets that investors consider “safe” will shrink by $9 trillion by 2016.

“We have no sellers,” Charles Comiskey, head of trading at Bank of Nova Scotia in New York, one of the 21 primary dealers of U.S. government securities that trade with the Fed, said in a phone interview on April 30.

Investors remain wary of Europe, where Greece, Portugal and Ireland have sought bailouts, and the potential for weaker growth in the U.S., according to Comiskey, who began his career in the debt markets at Morgan Stanley in 1985.

‘Next Shoe’

“It’s almost as though the Treasury market’s waiting for the next shoe to drop,” he said.

Declining volatility in Treasuries, stocks and currencies this year come as central banks inject trillions of dollars into the global financial system.

Bank of America Corp.’s Market Risk index, which measures future price swings implied by options on equities, fixed- income, currencies and commodities, fell to minus 0.69 on May 1, the lowest since October 2007 and down from positive 0.28 at the beginning of the year. A negative number means lower-than-normal volatility expectations based on data going back to 2000.

Ten-year Treasury notes rose in each of the past seven weeks, the longest rally since the period ended Dec. 19, 2008. Its yield fell six basis points last week, or 0.06 percentage point, to 1.88 percent in New York, Bloomberg Bond Trader prices show. The benchmark 2 percent security due in February 2022 gained 16/32, or $5 per $1,000 face amount, to 101 2/32.

No ‘Traction’

Yields fell as low as 1.87 percent on May 4 after the Labor Department said payrolls climbed 115,000 in April, the smallest increase in six months. The median estimate of 85 economists surveyed by Bloomberg News called for a 160,000 advance.

Ten-year yields slid as low as 1.82 percent today, the least since Feb. 3 after elections in France and Greece raised concern governments in the region will slow or abandon deficit- cutting plans used to combat Europe’s debt crisis.

The record low yield was 1.67 percent in September 2011, compared with the average over the past 20 years of 4.93 percent.

“You’ve got this economy that can’t get any sustained period of traction,” Mitchell Stapley, the Grand Rapids, Michigan-based chief fixed-income officer for Fifth Third Asset Management, said in a telephone interview. Fifth Third oversees $22 billion in assets.

Investors are hesitant to abandon the safety of Treasuries without further signs of strength in the global economy, especially Europe. The economy of the 17 nations that share the euro will shrink 0.3 percent in 2012 after expanding 1.4 percent in 2011, the IMF said April 17. The Washington-based lender said world growth would slow to 3.5 percent from 3.9 percent.

Volatility Outlook

Economic concerns and tame inflation outweigh a U.S. budget deficit exceeding $1 trillion and an increase in marketable Treasury securities outstanding to $10.4 trillion from $4.34 trillion in mid-2007.

Options on swaps, whose rates historically have mirrored the trend in Treasury yields, also signal that traders see little risk for big swings through the next 12 months, past the November U.S. election between President Barack Obama and likely challenger Mitt Romney.

Normalized volatility on one-year options for 10-year U.S. interest rate swaps, or 1y10y swaptions, reached as low as 85.5 basis points on May 4, the lowest since November 2007. Swap rates serve as benchmarks for investors in many types of debt, including securities backed by mortgages and auto loans.

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