U.S. 10-year notes (CBOT:ZNH14) headed for the worst annual performance in four years before the government sells $21 billion of them in its last auction of the securities for 2013. Budget negotiators unveiled an agreement yesterday to ease automatic spending cuts by about $63 billion over two years and cut the deficit by $23 billion, ending a three-year cycle of fiscal standoffs.
“It would have to slightly increase the odds of a December taper,” said William O’Donnell, head U.S. government-bond strategist at Royal Bank of Scotland Group Plc’s RBS Securities unit in Stamford, Connecticut, one of 21 primary dealers that trade with the U.S. central bank. “We may be closer to the point where the Fed feels job gains are sustainable.”
The benchmark 10-year yield rose two basis points, or 0.02 percentage point, to 2.82% at 10:50 a.m. in New York, after falling seven basis points during the previous three days, according to Bloomberg Bond Trader data. The price of the 2.75% note maturing in November 2023 decreased 5/32, or $1.56 per $1,000 face value, to 99 3/8.
Ten-year securities were poised for a 6.7% loss in 2013, the biggest drop since a 9.7% slide in 2009, Bank of America Merrill Lynch indexes show. Yields climbed more than 1 percentage point this year as improvement in the U.S. economy led traders to prepare for the Fed to reduce its bond purchases.
The notes being sold today yielded 2.83% in pre-auction trading. Bids are due by 1 p.m. New York time. The 10-year debt offering on Nov. 13 drew a yield of 2.75%, after selling at 2.657% the previous month.
The November sale’s bid-to-cover ratio, which gauges demand by comparing the amount bid with the amount offered, was 2.70, versus an average of 2.71 at the past 10 auctions. The offering drew the most demand in five months from the investor class that includes foreign central banks. Indirect bidders purchased 47.7% of the notes, the most since June.
The Treasury auctioned $30 billion of three-year notes yesterday at a yield of 0.631%, and plans to offer $13 billion of 30-year bonds tomorrow.
“Supply and the budget news are weighing on the market,” said Sean Murphy, a trader in New York at the primary dealer Societe Generale SA. “The Fed has been looking to the government for help, and the budget deal looks like it has a lot more substance, which means they got assistance on the fiscal side, which brings us closer to Fed tapering.”
U.S. Senator Patty Murray, a Democrat, and Republican Representative Paul Ryan said the budget proposal avoids a government shutdown and helps the economy. A partial closure in October lasted for 16 days because lawmakers couldn’t agree on how to fund the government.
Fed policy makers meet Dec. 17-18. They’re considering reducing debt purchases “in coming months” if the economy improves as expected, minutes of the central bank’s last session released in November showed. The Fed buys $85 billion of Treasury and mortgage debt each month to support the economy by putting downward pressure on borrowing costs.
The central bank will probably taper purchases in March if it doesn’t scale them back in December, said Daniel Fuss, a fund manager at Loomis Sayles & Co., which had $194 billion in assets as of Sept. 30. He said in a briefing in Tokyo today he’s “greatly reducing” long-maturity bonds.
U.S. retail sales accelerated in November, economists in a Bloomberg survey forecast before the Commerce Department report tomorrow. The jobless rate fell to a five-year low of 7%, manufacturing expanded at the fastest pace in more than two years, and purchases of new U.S. homes surged to the most in three decades, data this month showed.
The extra yield Treasury 10-year notes offer over the U.S. inflation rate was 1.84 percentage points, almost the highest in more than two years. Real yields reached 1.91 percentage points on Dec. 5, the highest since February 2011, data compiled by Bloomberg show.
Slow inflation may temper Treasuries’ losses. The Fed’s preferred measure, the personal consumption expenditures deflator, showed last week prices rose 0.7% in October, the least since 2009. It has failed to meet the Fed’s 2% target for 18 months.
The difference between yields on 10-year notes and comparable Treasury Inflation Protected Securities, a gauge of expectations for consumer prices over the life of the debt known as the 10-year break-even rate, was 2.13 percentage points. The average over the past decade is 2.22 percentage points.
Bill Gross, who runs the world’s biggest bond fund at Pacific Investment Management Co., maintained his biggest holdings in Treasuries and U.S. government-related securities in November. The proportion of the securities in the $244 billion Total Return Fund was 37%, unchanged from October, according to data from the company’s website.
U.S. 10-year yields will increase to 3.41% by the end of 2014, according to a Bloomberg survey of economists with the most recent projections given the heaviest weightings.
The benchmark note yields will rise to 3.75% next year, Bank of America Merrill Lynch Global Research said in a report yesterday. For an investor who bought today, an increase to that level by the close of 2014 would bring a loss of about 4%, according to data compiled by Bloomberg.