Treasury Two-Year Notes Advance for Sixth Week on Fed Rate View

May 21, 2011, 12:55 AM EDT By Cordell Eddings

May 21 (Bloomberg) -- Treasury two-year notes rose for a sixth week in the longest winning streak since August as manufacturing and housing weakness reinforced bets that the Federal Reserve will keep borrowing costs low.

Benchmark 10-year securities advanced as New York Fed President William Dudley said the central bank is falling short of its goals because of the modest pace of the recovery, with unemployment too high and inflation likely to ease. The government will sell $35 billion of two-year notes, the same amount of five-year notes and $29 billion of seven-year notes next week in three daily consecutive sales starting May 24.

“The economic weakness continues to catch the market offside,” said Thomas di Galoma, managing director of U.S. government securities at Oppenheimer & Co. “ Quantitative easing hasn’t spurred as much economic activity as people had hoped, so the Fed will stay accommodative until things turn around.”

Two-year note yields dropped two basis points, or 0.02 percentage point, to 0.52 percent in New York, according to Bloomberg Bond Trader prices. The price of the 0.625 percent security maturing in April 2013 increased 1/32, or 31 cents per $1,000 face amount, to 100 7/32.

Yields on 10-year notes fell two basis points to 3.15 percent after touching 3.09 percent on May 18, the lowest level since Dec 7. The yields dropped that day to within a basis point of the 200-day moving average, then 3.08 percent.

U.S. bill rates were at almost record lows as government authorities curtailed short-term debt issuance to conserve borrowing capacity, with the U.S. reaching its federal borrowing threshold of $14.3 trillion.

U.S. Debt Limit

Treasury Secretary Timothy F. Geithner said this week that he has acted to stave off the federal debt limit until Aug. 2, using accounting measures that involve two retirement funds.

Six-month rates were at 0.09 percent, compared with the record low 0.0305 percent set May 6. Three-month bill rates were at 0.04 percent, almost the lowest level since they went negative during the financial crisis.

U.S. government notes advanced as reports showed manufacturing in the Philadelphia area expanded at the slowest pace in seven months and sales of existing homes in the U.S. unexpectedly fell.

The Philadelphia Fed’s factory index slid this month to 3.9, the lowest level since October, from 18.5 in April. Readings greater than zero signal expansion. Existing home sales fell 0.8 percent last month after a 3.5 percent increase in March, the National Association of Realtors reported. The median forecast of 75 economists in a Bloomberg News survey was for a 2 percent increase.

‘Headwinds to Growth’

“The economic data continue to underwhelm,” said Scott Graham, head of government bond trading at Bank of Montreal’s BMO Capital Markets unit in Chicago. “People are looking at the Fed, and the headwinds to growth continue to argue for them keeping rates lower for a longer period. We are at this level for a reason.”

Fed Chairman Ben S. Bernanke told reporters after the central bank’s April policy meeting that he was unsure when stimulus would end after a $600 billion program of debt buying stops in June. The central bank bought $18.52 billion of nominal Treasuries and inflation-index debt during the week to support the economy.

Interest-rate futures indicated yesterday a 30 percent chance that the central bank will increase the target lending rate at its March 2012 meeting, compared with 50 percent odds a month ago. The target rate for overnight lending between banks has stayed at zero to 0.25 percent since December 2008.

Dudley’s View

The central bank has “a considerable way to go” before it meets its dual mandate of full employment and price stability, Dudley said on May 19 in New Paltz, New York.

Yields on 10-year Greek debt surged yesterday as much as 59 basis points to a record 16.59 percent. The 10-year bund yield touched 3.05 percent, the lowest level since January.

Greece’s credit rating was cut three levels by Fitch Ratings, which said that even a voluntary restructuring of the country’s debt being considered by European Union policy makers would be considered a default. Fitch lowered its rating to B+, four levels below investment grade, from BB+ and said that the country may face a further reduction in its creditworthiness.

Spain’s Prime Minister Jose Luis Rodriguez Zapatero’s Socialists were headed for defeat in elections on May 22 after a week of protests over his economic policies, polls show. The Bundesbank said in a monthly bulletin that Germany’s economy will probably lose some growth momentum over the coming months after an “explosive” start to the year.

“Keeping an underlying bid in the market is the combination of global sovereign risk out of Europe, the Fed that is still buying, and a clearer picture of the economy that shows it is beginning to stumble,” said Larry Milstein, managing director of government and agency debt trading in New York at R.W. Pressprich & Co., a fixed-income broker and dealer for institutional investors.

--Editors: Dennis Fitzgerald, Dave Liedtka

To contact the reporter on this story: Cordell Eddings in New York at ceddings@bloomberg.net

To contact the editor responsible for this story: Dave Liedtka at dliedtka@bloomberg.net

View the original article here