The difference between the yields on two-year debt and 10-year notes steepened to almost the most since May on optimism the global economic recovery is strengthening, reducing demand for safe-haven assets.
Treasury benchmark 10-year note yields touched a one-week high as demand for Italian bonds at an auction indicated the region’s debt crisis is easing. U.S. government debt declined yesterday after European Central Bank President Mario Draghi said the euro-area economy will slowly return to health in 2013. Italian 10-year bonds extended an advance, narrowing the yield difference, or spread, over similar-maturity German bunds to less than 250 basis points, or 2.5 percentage points, for the first time since July 22, 2011.
“There has been more optimism and increasingly less concern over Europe, and other sovereigns, which have performed better of late,” said Sean Murphy, a trader at Societe Generale SA in New York, one of the 21 primary dealers that deal with the Federal Reserve. “As we get closer to 2 percent, investors will jump back into the market. But, until then, we should see more volatility than people think.”
The 10-year yield fell two basis points, or 0.02 percentage point, to 1.87 percent as of 1:19 p.m. New York time after climbing to 1.93 percent, the highest level since Jan. 4, according to Bloomberg Bond Trader prices. The price of 1.625 percent note due in November 2022 rose 6/32, or $1.88 per $1,000 face value, to 97 25/32.
The yield on the 30-year bond fell three basis points to 3.05 percent.
Yield Spread
Italy sold 3.5 billion euros of debt maturing in December 2015 at an average yield of 1.85 percent, down from 2.50 percent at the previous auction on Dec. 13.
The difference in yields on U.S. two-year notes and 10-year debt expanded to as much as 1.67 percentage points after touching 1.69 percentage points on Jan. 4, the widest since May 4. The average last year was 1.52 percentage points.
U.S. government securities traded close to the least expensive levels in eight months. The 10-year term premium, a model created by economists at the Fed that includes expectations for interest rates, growth and inflation, was negative 0.69 percent. It reached negative 0.68 percent on Jan. 3, the least costly since May.
A negative reading indicates investors are willing to accept yields below what’s considered fair value. The average last year was negative 0.77 percent.
‘Inflationary’ Fed
The Fed’s preferred measure of inflation expectations, the five-year, five-year forward break-even rate, was 2.82 percent, compared with a 2012 average of 2.6 percent. The gauge projects the expected pace of consumer price increases from 2018 to 2023.
“People still expect Fed policy will be inflationary,” said Brian Edmonds, head of interest rates at Cantor Fitzgerald LP in New York, a primary dealer. “Most signs in the economy show that it’s stabilizing and may get a bit better although it’s not close to any of the thresholds the FOMC talked about in terms of removing accommodation. We still have a long way to go.”
The Federal Open Market Committee for the first time in December linked the outlook for its main interest rate to unemployment and inflation targets. The central bank said the rate would stay close to zero “at least as long” as unemployment remains above 6.5 percent and inflation projections are for no more than 2.5 percent.
The unemployment rate, which has been above 7 percent since December 2008, held at 7.8 percent in November. In the 12 months ended in November, consumer prices rose 1.8 percent, the Labor Department reported in December.
Treasury Returns
The Fed purchased $5.6 billion of Treasuries maturing from October 2017 to September 2018 today as part of its monthly purchases of $85 billion of government and mortgage debt to spur the economy by putting downward pressure on interest rates.
Treasuries handed investors a loss of 0.6 percent this year through yesterday, according to Bank of America Merrill Lynch indexes. German bonds dropped 1.6 percent and Japan’s fell 0.1 percent, the data show.
The MSCI All-Country World Index of shares returned 3 percent in 2013 including reinvested dividends, according to data compiled by Bloomberg.
“There could be some slight easing in yields in the U.S. as the risk-on tone loses momentum,” said Patrick Jacq, a senior fixed-income strategist at BNP Paribas SA in Paris. “Economic fundamentals are weighing very slightly on price action. It makes sense to see some consolidation today.”
