Deflation dismissed by bond measure amid QE3 anticipation

Rising Yields

Treasuries fell last week as investors saw less need to hold the safest assets after European Central Bank President Mario Draghi said policy makers would do whatever it takes to preserve the euro, sending the currency and stocks higher.

Treasury 10-year yields rose nine basis points, or 0.09 percentage point, to 1.55 percent, according to Bloomberg Bond Trader prices. The benchmark 1.75 percent note due May 2022 fell 27/32, or $8.44 per $1,000 face amount, to 101 26/32.

The yield, which reached an all-time low of 1.3790 percent on July 25, fell four basis points to 1.51 percent as of 12:38 p.m. in New York.

Bonds declined last week even though the Commerce Department in Washington said on July 27 that gross domestic product rose at a 1.5 percent annual rate last quarter after a revised 2 percent gain in the three months ended March 31. The rate, which was the slowest since the third quarter of 2011, compared with the 1.4 percent median estimate of 82 economists surveyed by Bloomberg.

The government will say Aug. 3 the unemployment rate held above 8 percent in July for the 42nd-straight month, the median estimate of more than 65 economists surveyed by Bloomberg shows.

QE Odds

“You don’t need to pump up inflation, but what you’re looking at is them wanting to support growth.” Scott Sherman, an interest-rate strategist at Credit Suisse Group AG in New York, said in a July 25 telephone interview.

The firm, one of the 21 primary dealers of government securities that trade with the Fed, forecasts a 30 percent probability of the Fed announcing QE3 at its two-day meeting ending Aug. 1, with the odds rising to 60 percent at the Sept. 13 gathering if the economy continues to weaken.

Investors have been willing to buy bonds that pay less than the rate of inflation because of the safety they offer as Europe’s debt crisis intensifies and the global economy slows. Spain and Cyprus joined Greece, Portugal and Ireland in seeking bailouts from the European Union.

Average Yield

The average yield on bonds issued by the Group of Seven nations dropped to 1.125 percent on July 27 from 3 percent in 2007, Bank of America Merrill Lynch index data show. Germany’s two-year note yield fell below zero for the first time on June 1, while Switzerland’s has been negative since April 24, meaning investors are paying for the right to lend those nations money.

Central banks are digging deeper into their tool kits in search of innovative ways to bolster their economies.

The People’s Bank of China joined the ECB on July 5 in cutting its benchmark rate, while the Bank of England raised the size of its asset purchases. Two weeks earlier, the Fed expanded a program lengthening the maturity of bonds it holds in a program traders call Operation Twist.

With U.S. yields at record lows, some investors doubt more Fed stimulus will work, according to James Sarni, a senior managing partner at Los Angeles-based Payden & Rygel, which manages $60 billion.

“Buying more mortgages or buying more Treasuries or agencies, I just don’t think it’s going to do much good,” Sarni said in a July 25 telephone interview. “The Fed cannot unilaterally solve all the world’s problems.”

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