Yield curve lowest in post Great Recession era

December 8, 2014 04:37 AM

The difference between yields on U.S. five-year notes and 30-year bonds narrowed to least in almost six years as below-target inflation makes longer-term securities relatively more attractive.

Bonds led gains as the Federal Reserve’s preferred gauge of price pressures hasn’t been above the U.S. central bank’s 2 percent inflation target since March 2012. Treasuries fell Dec. 5 after the Labor Department reported faster-than-forecast jobs gains for November. The U.S. plans to sell $59 billion of notes and bonds this week.

“The long end has mainly traded on inflation expectations coming way down in the U.S. and globally,” said Christopher Sullivan, who oversees $2.4 billion as chief investment officer at United Nations Federal Credit Union in New York. “Friday’s labor-market report exceeded expectations considerably and caused the flattening.”

The gap between yields on U.S. five-year notes and 30-year bonds, which reflects market trends with less influence from the Fed, which has held short-term rates at virtually zero since December 2008, narrowed to 1.25 percentage points, the least since January 2009, at 10:34 a.m. New York time.

Market Prices

Thirty-year bond yields fell three basis points to 2.93 percent. The yield rose eight basis points last week.

The Treasury is scheduled to sell $25 billion of three-year notes tomorrow, $21 billion of 10-year debt the next day and $13 billion of 30-year bonds Dec. 11.

The yield advantage for 10-year Treasuries compared with German bunds of comparable maturity rose to 1.58 percentage points, the widest since 1999.

“One of the reasons why the curve was able to continue to stay flatter is because of the underlying bid that’s in the European market,” said Thomas Tucci, managing director and head of Treasury trading in New York at CIBC World Markets Corp. “That seems to have a bigger impact on the longer end than the front end.”

The difference between yields on 10-year notes and similar- maturity Treasury Inflation Protected Securities, a gauge of trader expectations for consumer prices over the life of the debt, narrowed to 173 basis points, touching the lowest level in more than three years.

Fed Policy

The Fed will raise its benchmark in about 8 1/2 months, based on data compiled by Morgan Stanley. The median forecast by analysts in a Bloomberg survey is for a 25 basis-point rate increase in the second quarter of next year.

“With the front end suffering from anxiety about the Fed and disinflation pressures on the rise, the long-end of the curve continues to be the safe harbor,” Ward McCarthy and Thomas Simons at Jefferies Group LLLCwrote in a report on Dec. 5. The New York-based company is another primary dealer.

The U.S. added 321,000 jobs in November, a government report showed Dec. 5, exceeding the most optimistic projection in a Bloomberg News survey of economists. The gain followed a 243,000 advance in October that was stronger than previously reported. The jobless rate held at a six-year low of 5.8 percent. Average hourly earnings rose 0.4 percent, the most since June of last year.

The personal consumption expenditures index rose 1.4 percent in October from the same period a year ago.

Economic Outlook

Reports in the U.S. this week will show retail sales rose in November while costs for imported goods and producer prices fell, based on Bloomberg surveys of economists.

Based on bond yields, inflation expectations during the next 30 years have fallen below 2 percent and reached a three- year low of 1.96 percent at the end of last month.

Those levels are more akin to inflation rates that were prevalent in the five decades after the Fed was established in 1913. Living costs rose an average 2.45 percent annually during that span, versus 4.3 percent in the half-century since, according to data compiled by the Labor Department.

Long-term U.S. bond yields were also lower in the earlier period, averaging about 3.1 percent, according to more than 100 years of data provided by Austin, Texas-based Hoisington Investment Management.

“Over time, what drives the bond yield is the inflationary expectations,” Lacy Hunt, the 72-year-old chief economist at Hoisington, said by telephone on Dec. 2. “If you wring all the inflationary expectations out, you are going down to 2 percent on the long bond over the next several years. That is the path that we are on.”

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