Treasury yields tumble to records as Europe spurs refuge demand

Inflation Watch

“I don’t think there’s any inflation in the cards, not with the slack in the labor markets and the headwinds being presented by the European crisis,” said David Coard, head of fixed-income trading in New York at Williams Capital Group, a brokerage for institutional investors.

A measure of price-increase predictions used by the Fed to set policy, the five-year, five-year forward break-even rate, which gauges the average inflation rate between 2017 and 2022, was 2.53 percent on May 25, down from a 2012 high of 2.78 percent on March 19. The rate slid nine basis points in April, the biggest monthly decline since December.

The difference between yields on Treasuries maturing in two and 30 years, known as the yield curve, narrowed to 2.45 percentage points, the lowest since January 2009.

“Investors are creeping out the curve looking for yield,” Barclays’ Pond said. “If it were a normal flight to quality, investors would just flock into the short end.”

Benchmark Securities

Yields on U.S. 10-year notes, which are benchmarks for everything from mortgages to corporate bonds, fell in each of the nine weeks through May 18, the longest stretch since 1998. Treasuries gained for nine weeks through the period ended Oct. 2, 1998, when investors sought safety amid declines in Asian currencies, a default by Russia on its sovereign debt and the collapse of hedge fund Long-Term Capital Management LP.

While the amount of Treasuries outstanding has more than doubled to $10.4 trillion since 2007, a decline in securities globally deemed safe enough to meet tougher bank regulations has made the debt seem scarce. Citigroup Inc. says the pool of “high-quality” debt from the U.S., U.K., Germany and nine other European countries is 72 percent of what it was in 2007.

“There is no interest-rate bogey man lurking ahead,” said Kevin Flanagan, a Purchase, New York-based fixed-income strategist for Morgan Stanley Smith Barney. “I can’t make the argument for rates to move up visibly higher from here because you still have all of these forces weighing on the whole U.S. rate structure.”

Bank Demand

Banks have increased Treasury holdings 5.2 percent since December to $475.8 billion while boosting their stake in mortgage debt sold by government sponsored enterprises Fannie Mae and Freddie Mac 7.4 percent to $1.3 trillion, Fed data show. The combined amount is up from $1.25 trillion in 2008.

Primary dealer holdings of U.S. government debt rose to $108 billion, the highest ever, as of May 16, from a net bet against the securities of $11.9 billion in September, according to the Fed. Banks have added Treasuries to meet revised reserve rules from the Dodd-Frank financial-overhaul law and Basel III regulations set by the Bank for International Settlements in Basel, Switzerland.

Central banks, led by the Fed, have also taken Treasuries out of the market. The Fed has increased its position in U.S. government debt to $1.67 trillion from $475 billion in March 2009 as it undertook two rounds of asset purchases to bolster the economy. Foreign central banks hold $2.78 trillion of U.S. government debt in custody at the Fed, a $90.6 billion or 3.4 percent increase from the end of 2011, central bank data shows.

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