Treasuries snap advance before Fed announces taper decision

Dec 18, 2013 @ 7:33 am

Treasuries snapped the biggest advance in a month before the Federal Reserve announces a decision today on whether it will slow asset purchases from $85 billion a month.

The difference between two- and 10-year yields was 2.51 percentage points, versus an average 2 percentage points during the past year. Two-year yields are anchored by what the Fed does with its target rate, while 10-year yields are more influenced by the central bank's debt-purchase program. Fed Chairman Ben S. Bernanke will hold a press conference in Washington after the decision. The U.S. plans to sell $35 billion of five-year securities Wednesday in the second of four note auctions this week.

“It's a very close call whether they do taper today or at the start of next year,” said Christoph Rieger, head of interest-rate strategy at Commerzbank AG in Frankfurt. “We think there won't be tapering today but in the press conference Bernanke should open the door widely to a taper early next year. Yields will rise next year, mainly due to macro fundamentals improving.”

The benchmark 10-year yield climbed 1 basis point, or 0.01 percentage point, to 2.85% at 7:03 a.m. in New York, according to Bloomberg Bond Trader prices. The 2.75% note due in November 2023 fell 1/8, or $1.25 per $1,000 face amount, to 99 5/32. The yield dropped 4 basis points yesterday, the biggest decline since Nov. 13.

While the yield has risen from 1.76% at the end of 2012, it's still less than the average of 3.49% during the past decade. Treasuries handed investors a loss of 2.7% this year through Tuesday, Bloomberg World Bond Indexes show.

A decision not to taper should see Treasuries rise in a “knee-jerk reaction providing some initial relief,” Mr. Rieger said. This would likely be short-lived given the comments Bernanke is likely to make Wednesday, he said.

The Fed has kept its benchmark rate, the target for overnight loans between banks, at almost zero for five years. The odds of an increase by January 2015 are about 13%, based on data compiled by Bloomberg from futures contracts.

The Fed will start reducing purchases this month, according to 34% of economists surveyed by Bloomberg on Dec. 6. Twenty-six percent forecast January and 40% said March.

PIMCO VIEW

There's up to a 60% chance the Fed will announce a reduction in purchases on Wednesday, said Mohamed El-Erian, chief executive officer of Pacific Investment Management Co.

When the central bank does taper, policymakers will offer a package of policies, which may include a change in how much they pay banks on excess reserves, thresholds for changing programs and forward guidance on policy, Mr. El-Erian said Tuesday.

“The market is going to be reacting to the package and not just one element,” he said.

A $32 billion auction of two-year notes yesterday drew the strongest demand in 11 months. The bid-to-cover ratio, which compares bids submitted with the amount of securities offered, increased to 3.77 times from 3.54 times in November.

Debt offerings this week also include Tuesday's five-year sale as well as $29 billion of seven-year notes and $16 billion of five-year Treasury inflation-protected securities Thursday.

The five-year notes scheduled for sale Wednesday yielded 1.55% in pre-auction trading, compared with 1.34% at a previous sale on Nov. 26.

RALLY POSSIBLE

“That's a lot of paper coming into the market two days before everybody's leaving to go on vacation for the rest of the year,” said John Gorman, head of dollar-denominated interest- rate products at Nomura Singapore Ltd. “You're going to have to see a lot of concession on Thursday. I've been talking to a lot of accounts that are looking to bid in the auction because they're looking for a concession, and they think that once this paper is through, the market could rally.”

To gauge whether investors are demanding additional yield to buy the new securities, Mr. Gorman tracks the butterfly spread, which compares yields on seven-year notes relative to five- and 10-year Treasuries.

The spread was 7 basis points today, versus this year's average of -5 basis points, with the widening reflecting waning demand for the middle security over the other two. The figure may be about 8 basis points before tomorrow's auction, Mr. Gorman said.

Funds that manage their portfolios against benchmark indexes may help buoy Treasuries as December closes, said Mr. Gorman at Nomura, whose U.S. arm is one of the 21 primary dealers that underwrite the Treasury's debt. As the benchmarks incorporate each month's auctions, fund managers buy to match the adjustment.

(Bloomberg News)

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