Treasury Yield Curve Steepens

Latest round of Fed stimulus stirs inflation speculation.

The yield gap between 10- and 30-year Treasuries widened to the most in a year on concern the Federal Reserve’s plan to buy more debt and pledge to keep monetary policy accommodative even when the economy strengthens will spur inflation.

The difference touched 1.21 percentage points, the most since August 2011, as yields on 30-year debt, more sensitive to inflation because of its longer maturity, climbed to the highest since May. The drop in prices followed a $13 billion sale of bonds just before the Federal Open Market Committee said it would expand its holdings of long-term securities with mortgage- debt purchases. It also said it would probably keep interest rates at virtually zero into 2015.

“They are erring on the side of trying to promote additional growth,” said Jeff Phlegar, chairman and chief executive officer in New York at MacKay Shields LLC, an advisory firm that oversees $70 billion in fixed-income assets. “They are not concerned about inflation.”

Thirty-year bond yields rose three basis points, or 0.03 percentage point, to 2.95 percent at 3:50 p.m. New York time and reached 3 percent, the highest level since May 14.

Yields on 10-year notes fell two basis points to 1.74 percent after rising to 1.83 percent, the highest since Aug. 21. They fell to a record 1.379 percent on July 25 and climbed to a three-month high of 1.86 percent on Aug. 21.

Other assets rallied after the Fed’s statement, with the Standard & Poor’s 500 Index climbing 1.7 percent and gold futures gaining as much as 2.4 percent to $1,775 an ounce.

The difference in yield between 10-year notes and similar-maturity Treasury Inflation Protected Securities, a gauge of traders’ outlook for consumer prices known as the break-even rate, reached 2.49 percentage points, the most since July 2011. It has averaged 2.2 percent this year.

FOMC officials upgraded their estimate for 2013 gross domestic product growth to 2.5 percent to 3 percent, compared with 2.2 percent to 2.8 percent in June. Estimates for 2014 are from 3 percent to 3.8 percent, versus 3 percent to 3.5 percent in the previous forecast.

Almost two-thirds of economists in a Bloomberg survey had forecast the central bank would announce more government debt purchases under quantitative easing. The Fed bought $2.3 trillion of Treasuries and mortgage-related debt in two rounds of the stimulus strategy from 2008 to 2011.

 

‘Will Continue’

“If the outlook for the labor market does not improve substantially, the committee will continue its purchases of agency mortgage-backed securities, undertake additional asset purchases and employ its other policy tools as appropriate,” the FOMC said today in a statement at the end of a two-day meeting in Washington.

The Fed will make open-ended purchases of $40 billion of mortgage debt a month as it seeks to boost economic growth and reduce employment, the committee said.

“A highly accommodative stance of monetary policy will remain appropriate for a considerable time after the economic recovery strengthens,” the FOMC said.

Yields on Fannie Mae-guaranteed mortgage bonds trading closest to face value declined 18 basis points to 2.18 percent as of 3:05 p.m. in New York, according to data compiled by Bloomberg. The gap with an average of five- and 10-year Treasury rates narrowed 16 basis points to about 98 basis points, the lowest since 1992.

The Fed’s approach may have been “on the light side” of expectations, said John Fath, a money manager at the investment firm BTG Pactual in New York who helps manage $2.5 billion in bonds. “If you look at when they did QE1 and QE2, inflation was at a lower level. Maybe it was more difficult with the hawks to overcome their opinions.”

Investors should buy seven-year Treasuries because the monthly purchases outlined by the Fed reflect a “fairly measured, although open-ended” approach that may last longer than earlier efforts, favoring intermediate maturities, Brett Rose, an interest-rate strategist in New York at Citigroup Inc., wrote in a note to clients. The firm is one of the 21 primary dealers that trade with the Fed.

Treasury 30-year bond yields reached their lowest level of the day, 2.86 percent, after the U.S. sold $13 billion of the securities before the Fed statement. The sale yielded 2.896 percent, compared with a forecast of 2.929 percent in a Bloomberg News survey of six primary dealers. The bid-to-cover ratio, which gauges demand by comparing total bids with the amount of securities offered, was 2.68, versus an average of 2.62 at the past 10 sales.

 

‘Grave Concern’

The central bank’s stimulus efforts since 2008 have failed to breathe life into the labor market, which Chairman Ben S. Bernanke said last month is a “grave concern.” Unemployment has been stuck above 8 percent for 43 straight months.

Bernanke said Aug. 31 in a speech in Jackson Hole, Wyoming, that a Fed study found the large-scale asset purchases may have raised the level of economic output by almost 3 percent and boosted private payroll employment by more than 2 million jobs.

U.S. gross domestic product was 1.7 percent in the second quarter, after reaching 4.1 percent from October through December, the highest since 2006, Commerce Department data show. The jobless rate was 8.1 percent in August, the Labor Department said on Sept. 7.

The number of Americans filing applications for unemployment benefits rose last week more than projected, data showed today. Initial jobless claims increased to 382,000, from 367,000 the previous week, the Labor Department reported.

“In the spirit of Halloween, it was more like a trick or treat,” Richard Schlanger, who helps invest $20 billion in fixed-income securities as vice president at Pioneer Investments in Boston, said of the Fed decision. “They provided some candy in the sense they will be buyers of mortgage-backeds, they provided the extended language that everybody was looking for, but they didn’t give away all the candy in the basket.”

The Fed also said today it will continue its Operation Twist program to replace shorter-term debt in its portfolio with longer-term securities to extend its holdings’ average maturity and put downward pressure on long-term borrowing costs.

 

 Bloomberg News

 

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