Treasury market volatility climbs

Treasuries dropped, with 10-year note yields reaching the highest level in three weeks, as monthly jobless claims at the lowest level in eight years added to evidence the employment market is strengthening.

U.S. government debt was poised for the biggest monthly drop since March on bets the Federal Reserve will raise interest rates after second quarter economic growth surged past analysts’ forecasts. The difference between yields on five-year notes (CBOT:ZFU14) and 30-year debt rose from the lowest levels since 2009 before the July jobs report tomorrow forecast to show a sixth straight month of 200,000-plus gains. Treasuries (CBOT:ZNU14) fell 0.1% this month through yesterday, matching June’s decline, Bloomberg World Bond Indexes show.

“People are starting to pay attention to the fundamentals -- normally they don’t,” said David Coard, head of fixed-income trading in New York at Williams Capital Group, a brokerage for institutional investors. “A solid number combined with GDP will probably knock the Treasury market back a little bit,” he said, refering to the employment report. Coard said the 10-year yields will need to rise to 2.75% to attract investors.

The U.S. 10-year yield, a benchmark for global borrowing costs, gained four basis points, or 0.04 percentage point, to 2.59% at 9:02 a.m. New York time, according to Bloomberg Bond Trader data. The price of the 2.5% note due in May 2024 was 99 6/32. The yield reached the highest level since July 8 and has increased seven basis points this month.

Price Swings

Treasury market volatility yesterday climbed to 56 basis points, the most since July 3, according to Bank of America Merrill Lynch’s MOVE Index, which measures price swings in Treasuries based on options. It dropped to 52.74 basis points on June 30, the lowest level since May 2013.

The extra yield that benchmark 10-year notes offer over their Group of Seven counterparts climbed as high as 78 basis points, the most since June 2007.

The extra yield investors earn on U.S. 10-year notes versus similar-maturity German bunds widened to 139 basis points, the most in 15 years based on closing prices, as euro-area inflation unexpectedly slowed to the weakest since 2009, adding to pressure on the European Central Bank to keep its rates at record lows.

U.S. gross domestic product grew at a 4% annualized rate in the second quarter, after shrinking a revised 2.1% from January through March, Commerce Department figures showed yesterday. The median forecast of economists surveyed by Bloomberg was for growth of 3%.

“The market had been steadily deciding that GDP was not going to be as big a bounce-back as originally hoped and was therefore caught by surprise,” said John Davies, a U.S. interest-rate strategist at Standard Chartered Bank in London. “Treasury yields, which had been eking out levels below 2.50%, had to reverse fairly promptly.”

Yield Difference

The difference between yields on five-year notes and 30-year debt, known as the yield curve, steepened to 155 basis points after narrowing yesterday to as low as 149 basis points.

The U.S. added more than 231,000 jobs in July, according to a Bloomberg News survey of economists before the Labor Department’s monthly employment report tomorrow.

Average hourly earnings increased 2.2% from a year earlier, according to the responses. While the figure would be the highest level this year, it has yet to recover from the recession that began in December 2007 and ended in June 2009. The measure climbed as high as 3.6% in 2008.

“Prospects for the U.S. economy in the second half look OK,” said Ali Jalai, a bond trader in Singapore at Scotiabank, a unit of Bank of Nova Scotia, one of 22 primary dealers that trade directly with the Fed. “The bond market sold off. Perhaps prices can fall a little bit more.”

Fed policy

The Fed reduced its monthly pace of debt purchases by $10 billion to $25 billion at a two-day meeting that ended yesterday.

Traders see about 87% odds the central bank will raise the target for its benchmark to at least 0.5% by September 2015, based on futures contracts. The figure was about 78% at the start of July.

Treasuries were heading for a gain this month until a sell- off yesterday. The securities rose earlier today as investors sought the safest assets after Standard & Poor’s said Argentina defaulted on its debt and Portugal’s Banco Espirito Santo SA was ordered to raise capital.

U.S. debt was also supported today as investors sought an alternative to record-low yields in Europe. Germany’s 10-year yield dropped to an unprecedented 1.109% this week.

Euro-region inflation was 0.4% compared with 0.5% in June, the European Union’s statistics office in Luxembourg said today, below a median forecast of 0.5% in a Bloomberg News survey of economists.

The 10-year yield will climb to 3.06% by year-end, according to a Bloomberg survey of economists with the most recent forecasts given the heaviest weightings.

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