Treasuries Loss Is Biggest in 3 Years as Fed Considers Tapering; Europe Bond Investors Lose in May as End of Cheap Cash Signaled

Treasuries Loss Is Biggest in 3 Years as Fed Considers Tapering

Treasuries recorded the steepest monthly loss since 2009 amid speculation the Federal Reserve could curtail its unprecedented monetary stimulus program if recent improvement in domestic economic data is sustainable.

U.S. government debt tumbled 1.8 percent in the month through May 30, the most since December 2009, according to Bank of America Merrill Lynch index data. Yields extended gains yesterday after a report showed consumer confidence rose in May to the highest level since 2007. A government report on June 7 is forecast to show the U.S. added 165,000 jobs in May and the unemployment rate remained at a four-year low of 7.5 percent.“This is where the battle is going on now — it’s all about what the Fed is going to do,” said Larry Milstein, managing director in New York of government-debt trading at R.W. Pressprich & Co. “The market’s going to overreact to the economic data that we get over the next couple of months because of that. The Fed is on hold right now and will look at economic data over the summer to decide whether or when to taper.”

The yield on 10-year Treasury notes rose 12 basis points this week, or 0.12 percentage point, to 2.13 percent in New York, according to Bloomberg Bond Trader data. The price of the 1.75 percent note due in May 2023 fell 1 2/32, or $10.63 per $1,000 face amount, to 96 20/32. The yield reached 2.23 percent May 29, the highest level since April 5, 2012.

Thirty-year bond yields climbed 11 basis points to 3.28 percent.

Market Trends

The 10-year yield surged 46 basis points since April 30, the most since jumping 50 basis points in December 2010. It is estimated to end the year at 2.20 percent, according to the median forecast of 75 economists and strategists in a Bloomberg News survey.

“We are in a bear market for Treasuries, but it doesn’t mean we will see rates rise sharply,” said David Coard, head of fixed-income trading in New York at Williams Capital Group LP, a brokerage for institutional investors, in a telephone interview May 30. “People are still skeptical about the economy and whether or not it will be strong enough to cause the Fed to actually taper. The economy is probably strong enough that over the balance of this year you’ll see rates rising.”

Yields rose yesterday after the Thomson Reuters/University of Michigan final index of sentiment increased to 84.5 in May, the strongest since July 2007, from 76.4 a month earlier. The median forecast in a Bloomberg survey called for the gauge to hold at its preliminary reading of 83.7.

Bond Returns

Treasuries have lost investors 1 percent this year after returning 2.2 percent in 2012. Securities in the Bank of America Merrill Lynch Global Broad Market Index have fallen 1.5 percent in May, poised for the steepest loss since April 2004.

“Everyone realizes there’s some risk that’s been put back into the bond market,” said Thomas Tucci, managing director and head of Treasury trading in New York at CIBC World Markets Corp., in an interview May 30.

Volatility as measured by the Bank of America Merrill Lynch MOVE index rose to 81.22 May 29, the highest level in almost a year. It was at 79.99 yesterday.

Trading volume rose to $631 billion on May 29, according to ICAP Plc, the largest inter-dealer broker of U.S. government debt. It reached $662 billion on May 22, the highest level in data going back to 2004. The average daily volume for this year has been $298 billion.

Futures Trade

Trading in Treasury futures reached a record on May 29, according to the CME Group in Chicago. Futures and options trading for 10-year notes totaled 5.9 million contracts and 3.6 million contracts for five-year futures and options, the CME said in a statement.

Hedge-fund managers and other large speculators increased their net-short position in 30-year bond futures in the week ending May 28, according to U.S. Commodity Futures Trading Commission data. Speculative short positions, or bets prices will fall, outnumbered long positions by 27,251 contracts on the Chicago Board of Trade, up from 9,583 contracts a week earlier.

Investors reversed to a net-short position in 10-year note futures of 35,505 contracts, the data show.

Volatility in Treasuries has increased as investors speculated on the Fed’s next move. The Fed is buying $85 billion of Treasury and mortgage debt a month to support the economy amid speculation it may taper even as inflation remains contained.

Inflation Watch

A gauge tracked by the Fed known as the personal consumption expenditure, or PCE, fell by 0.3 percent last month, the biggest drop since December 2008, a government report said yesterday.

The gap between 10-year Treasury yields and similar maturity Treasury Inflation Protected Securities, known as the 10-year break-even rate narrowed to 2.15 percentage points on May 30, the lowest level since July 2012. It rebounded to 2.19 percent yesterday.

Higher yields and historically low inflation levels bolstered demand for Treasuries at the government’s auctions of $99 billion in notes this week. The U.S. sold $35 billion in two-year securities on May 28, an equal amount in five-year debt the next day and $29 billion in seven-year notes on May 30.

“I guess we found the right attractive level, at least for the time being,” said Justin Lederer, an interest-rate strategist at primary dealer Cantor Fitzgerald LP in New York, in a telephone interview May 30.

To contact the reporters on this story: Susanne Walker in New York at swalker33@bloomberg.net

Europe Bond Investors Lose in May as End of Cheap Cash Signaled

Investors lost money in European corporate bonds for the first time in four months in May on speculation central banks will stem the flow of cheap cash that pushed borrowing costs to record lows.

Returns on investment-grade notes dropped to minus 0.5 percent for the month, compared with a 1 percent profit in April, according to Bank of America Merrill Lynch’s Euro Corporate index. Junk debt lost 0.1 percent after earning investors 2 percent the previous month.

Signs the global economy is recovering from the worst crisis since the Great Depression are prompting investors to brace for cuts in central bank stimulus programs. Federal Reserve Chairman Ben S. Bernanke said last week the pace of asset purchases could taper off if there is continued and sustained improvement in economic growth, while economic confidence in the euro region increased in May.

“Markets are anticipating the end to quantitative easing and therefore the crutch that it’s provided credit markets in keeping rates low will disappear and less liquid bond markets will sell off,” said Bill Blain, a strategist at Mint Partners Ltd. in London. “Already bonds priced off government benchmarks are under-performing in line with the rising rate environment, and it could get more pronounced.”

The average yield on European corporate bonds rose 12 basis points from a record low of 1.72 percent reached May 17, according to Bank of America Merrill Lynch’s Euro Corporate index. The premium investors demand to hold that debt instead of government bonds is holding near 112 basis points, the lowest since November 2007.

Worst Performers

Telecom Italia SpA (TIT)’s bonds were the worst-performing investment-grade securities in Europe, with investors in the country’s biggest phone company losing an average 2 percent over the month, Bank of America Merrill Lynch data show. Rexel SA (RXL), the French electrical equipment distributor, offered the poorest returns among junk-rated securities, with an average 1.5 percent loss, the data show.

ING Groep NV (INGA), the Netherlands’ largest financial-services company, led companies selling 56.7 billion euros ($73.4 billion) of bonds in May, compared with 66.2 billion euros in April, data compiled by Bloomberg show.

Speculative-grade borrowers including U.K. fashion retailer New Look Group Plc and Frigoglass SA (FRIGO), the Greek refrigerator equipment supplier, raised 8.6 billion euros of debt, compared with 10.4 billion euros last month.

Investors bought a record 46.6 billion euros of junk debt this year, according to data compiled by Bloomberg. The extra yield they demand to hold the notes reached 454 basis points on May 10, the lowest in 5 1/2 years, and was at 474 on May 30, Bank of America Merrill Lynch data show.

Credit Risk

“The fact that high-yield bonds have tightened so much, while remaining quite illiquid, means they’re mis-priced,” said Blain. “Investors who have neglected the fundamentals of credit and liquidity are about to be reminded why corporate bonds are more risky.”

The cost of insuring European corporate debt against default rose this month after reaching the lowest in two years on May 22. The Markit iTraxx Crossover Index of default swaps on 50 companies with high-yield credit ratings gained 19 basis points this month to 415 at 8:45 a.m. in London. The measure fell to 366 on May 22, the lowest level since May 2011.

The Markit iTraxx Europe Index of contracts on 125 investment-grade companies rose 3.5 basis points this month to 102. It reached a three-year low of 87 basis points on May 22.

The Markit iTraxx Financial Index linked to senior debt of 25 banks and insurers was little changed at 145 basis points, while the subordinated index fell 29 basis points to 206 after reaching 177 basis points on May 22, the lowest in almost three years.

A basis point on a credit-default swap protecting 10 million euros of debt from default for five years is equivalent to 1,000 euros a year. Swaps pay the buyer face value in exchange for the underlying securities or the cash equivalent should a borrower fail to adhere to its debt agreements.

To contact the reporter on this story: Katie Linsell in London at klinsell@bloomberg.net