The decline pushed up yields from their lowest close in 18 months as policy makers consider whether to retain a pledge to keep rates low for a “considerable time” after they ended monthly bond-buying in October. The Fed must weigh the pace of economic growth as a report showed industrial production increased last month by the most since May 2010, while crude oil was little changed after falling to five-year lows.
“The Fed takes precedent,” said Michael Franzese, senior vice president of fixed-income trading at ED&F Man Capital Markets in New York. The central bank may “leave considerable time in there and tell you that it could be removed in the next couple of meetings, and that they will begin the process of raising rates in May or June.”
The benchmark U.S. 10-year yield rose two basis points, or 0.02 percentage point, to 2.11% at 10:37 a.m. in New York, according to Bloomberg Bond Trader data. The 2.25% note due November 2024 dropped 7/32, or $2.19 per $1,000 face amount, to 101 1/4. The 2.08% close on Dec. 12 was the lowest since June 2013.
Treasuries returned 6.5% through Dec., 12, compared with a 9.7% gain from German securities, according to Bloomberg World Bond Indexes. Italian bonds earned 14% and Spanish debt gained 15%.
The difference between the yields on two-year and 30-year debt, known as the yield curve, narrowed to the least in almost six years. It touched 218 basis points, the least since January 2009.
The flatter yield curve, a chart of rates on securities of varying maturities, suggests investors are seeking longer maturities at the expense of shorter-dated notes, judging inflation will stay subdued even as the fed prepares to raise rates.
Fed Chair Janet Yellen and her fellow policy makers will gather in Washington tomorrow for their final two-day meeting of the year. The last time the Fed increased benchmark federal funds rate was in 2006.
Futures prices show a 57% chance the Fed will raise it interest-rate target by its September meeting, according to data compiled by Bloomberg.
“The big key is what these lower oil prices mean for the economy and for the Fed, and what’s the Fed going to say about it,” said Thomas Roth, senior Treasury trader in New York at Mitsubishi UFJ Securities USA Inc.
Data from Morgan Stanley suggest officials will raise borrowing costs in about 8 1/2 months. The weighted average forecast in a Bloomberg survey of analysts is for the benchmark rate to rise to 0.40% by the second quarter of next year, and to 0.65% in the third quarter.
Treasuries also fell as Industrial production surged in November by the most since May 2010, signaling manufacturing is bolstering economic growth.
The 1.3% gain in output at factories, mines and utilities followed a 0.1% increase the prior month that was previously reported as a decline, figures from the Fed showed. Manufacturing rose 1.1%, the most in nine months, and output at utilities was the strongest in almost eight years.
Industrial production “was strong across the board,” Roth of Mitsubishi UFJ said. “It is indicating a very healthy manufacturing economy.”
Crude oil (NYMEX:CLF15) rose from its lowest level in five years in London after Libya said it was unable to load cargoes at two ports. Crude oil futures were little changed at $57.80 a barrel in New York.
“Yields are rising in Treasuries and other markets as investors are positioning for a more hawkish Fed statement given the strength of data out of the U.S.,” said Michael Leister, a senior rates strategist at Commerzbank AG in Frankfurt. “A rebound in oil prices also contributed to the move today. In any case, yields at these levels are vulnerable for profit taking.”
An obscure corner of the $12.4 trillion market for U.S. government debt is providing one of the clearest signs yet that bond investors are writing off the threat of inflation for years, if not decades, to come.
Demand for Strips, created when Wall Street banks separate the interest payments from the principal of U.S. debt and sell each at a discount, has boosted the amount outstanding to an average $211 billion this year, the most since 1999, data from the Treasury Department show. The securities, the most vulnerable to inflation of all U.S. government bonds, posted the biggest returns this year by rallying almost 50%.
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