Treasury 10-Year Returns Jeopardized by Bernanke's Rate Plans
May 1 (Bloomberg) -- U.S. 10-year Treasuries may underperform two-year notes for the first time since 2003 after Federal Reserve Chairman Ben S. Bernanke raised investor concerns the central bank will fail to keep inflation in check.
Longer-maturity debt fell and Treasuries with shorter- maturities rallied last week as Bernanke suggested the central bank may slow the pace of interest-rate increases. Ten-year yields ended the week 19 basis points above those on two-year notes, the most since Nov. 4. The difference, known as the yield curve, was flat a month ago.
Economists at Barclays Capital Inc. said in an April 28 report that the reaction shows investors expect the Fed ``may fall behind the curve.'' Bernanke's comments in testimony to Congress caught investors off guard because commodity prices are close to records, sparking concern faster inflation will erode the purchasing power of fixed-coupon payments on 10-year notes.
``A declared bias by the Fed to pause imminently, with upside risks to inflation and inflation expectations, means the central bank risks not being credible,'' Wan-Chong Kung, whose group invests $20 billion at First American Funds in Minneapolis, said last week. ``We see the curve continuing to steepen.''
Steeper Curve
The Treasury's 4 1/2 percent note due February 2016 fell to 95 3/4 on April 28 from 96 1/16 a week earlier, sending its yield 4 basis points higher to 5.05, according to New York-based Cantor Fitzgerald LP.
The 4 7/8 note due April 2008, auctioned April 26, the day before Bernanke spoke, ended the week at 100 1/32 to yield 4.86 percent. The note yielded 4.975 percent when it was sold.
The gap in yields expanded by 8.2 basis points last week, the most since the period ended March 10, when a report showed wage growth accelerated in February.
The Fed's success under Alan Greenspan in keeping inflation subdued gave investors confidence to buy longer-maturity debt even as the central bank raised rates 15 times beginning in June 2004. Ten-year notes were little changed over that time while two year yields rose from 2.68 percent. Bernanke took over from Greenspan on Feb. 1.
``The Fed pausing or stopping means they're less vigilant in fighting inflation,'' Jeff Given, part of a group that manages $10 billion of bonds at John Hancock Advisers LLC in Boston, said last week. ``It will be a steeper Treasury curve going forward.''
Another Rate Rise
Two-year notes have returned 0.61 percent this year, compared with a loss of 4 percent for 10-year notes, according to Merrill Lynch & Co. index data. The last time 10-year note returns were lower than two-year securities was 2003, when they handed investors 1.32 percent. That was the year that the Fed was concerned consumer price gains were too low.
The Labor Department on April 19 said core consumer prices rose 0.3 percent in March, the most in a year.
Andrew Harding, who oversees $16 billion in cash and bonds at Allegiant Asset Management in Cleveland, said in an interview last week the yield curve may reach 50 basis points this year. He is considering adding to his holdings of two-year notes.
``Even if in the committee's judgment the risks to its objectives are not entirely balanced, at some point in the future the committee may decide to take no action at one or more meetings in the interest of allowing more time to receive information relevant to the outlook,'' Bernanke said.
The Fed has raised its target rate by 3.75 percentage points to 4.75 percent. Interest-rate futures, or bets on where the Fed's rate may be in a particular month, show traders are certain policy makers will boost rates on May 10 to 5 percent. There is a 28 percent chance of another quarter-point increase by July, down from 64 percent on April 26, futures show. The odds of it reaching 5.25 percent in August are 52 percent.
Risk Compensation
Long-term securities typically yield more than short-term debt because investors want to be compensated for the risk that inflation accelerates over the life of the bond.
Over the past 20 years, 10-year Treasury yields exceeded two- year yields by an average of 88 basis points. The curve inverted for the first time since 2001 on Dec. 28, and two-year yields exceeded 10-year yields by as much as 16 basis points on Feb. 23 after the Fed raised its target rate by a quarter point to 4.50 percent and signaled more were on the way.
Michael Roberge, who oversees $40 billion as chief fixed- income officer at MFS Investments in Boston, said April 28 that the yield curve is about where it should be.
``The steepness of the curve now is fair,'' he said. ``We would become more concerned if the economy continues to grow pretty rapidly and the Fed prematurely goes on hold.''
Inflation Protection
First American's Kung said she's concerned high energy and commodity prices will seep into core inflation after reports last week showed consumer confidence and new and existing home sales all unexpectedly rose.
Yields on 10-year Treasury inflation-protected securities, or TIPS, declined more than those on regular Treasuries, as investors were willing to pay more for bonds that protect them against rising consumer prices.
The gap between yields on TIPS and regular Treasuries due in 2016 widened 6 basis points after Bernanke's testimony to as much as 2.68 percentage points, the highest since April 2005. The difference is the average inflation rate investors expect over the next decade.
``The market is beginning to price a Fed that may fall behind the curve,'' Dean Maki, chief U.S. economist at Barclays in New York wrote in the report. ``The risks in the near term are a continuation of this move with higher rates and a steeper curve as risk premium and increased inflation expectations are priced in.''
To contact the reporter on this story:
Deborah Finestone in New York at dfinestone@bloomberg.net;
Al Yoon in New York at ayoon@bloomberg.net.
Last Updated: April 30, 2006 11:
May 1 (Bloomberg) -- U.S. 10-year Treasuries may underperform two-year notes for the first time since 2003 after Federal Reserve Chairman Ben S. Bernanke raised investor concerns the central bank will fail to keep inflation in check.
Longer-maturity debt fell and Treasuries with shorter- maturities rallied last week as Bernanke suggested the central bank may slow the pace of interest-rate increases. Ten-year yields ended the week 19 basis points above those on two-year notes, the most since Nov. 4. The difference, known as the yield curve, was flat a month ago.
Economists at Barclays Capital Inc. said in an April 28 report that the reaction shows investors expect the Fed ``may fall behind the curve.'' Bernanke's comments in testimony to Congress caught investors off guard because commodity prices are close to records, sparking concern faster inflation will erode the purchasing power of fixed-coupon payments on 10-year notes.
``A declared bias by the Fed to pause imminently, with upside risks to inflation and inflation expectations, means the central bank risks not being credible,'' Wan-Chong Kung, whose group invests $20 billion at First American Funds in Minneapolis, said last week. ``We see the curve continuing to steepen.''
Steeper Curve
The Treasury's 4 1/2 percent note due February 2016 fell to 95 3/4 on April 28 from 96 1/16 a week earlier, sending its yield 4 basis points higher to 5.05, according to New York-based Cantor Fitzgerald LP.
The 4 7/8 note due April 2008, auctioned April 26, the day before Bernanke spoke, ended the week at 100 1/32 to yield 4.86 percent. The note yielded 4.975 percent when it was sold.
The gap in yields expanded by 8.2 basis points last week, the most since the period ended March 10, when a report showed wage growth accelerated in February.
The Fed's success under Alan Greenspan in keeping inflation subdued gave investors confidence to buy longer-maturity debt even as the central bank raised rates 15 times beginning in June 2004. Ten-year notes were little changed over that time while two year yields rose from 2.68 percent. Bernanke took over from Greenspan on Feb. 1.
``The Fed pausing or stopping means they're less vigilant in fighting inflation,'' Jeff Given, part of a group that manages $10 billion of bonds at John Hancock Advisers LLC in Boston, said last week. ``It will be a steeper Treasury curve going forward.''
Another Rate Rise
Two-year notes have returned 0.61 percent this year, compared with a loss of 4 percent for 10-year notes, according to Merrill Lynch & Co. index data. The last time 10-year note returns were lower than two-year securities was 2003, when they handed investors 1.32 percent. That was the year that the Fed was concerned consumer price gains were too low.
The Labor Department on April 19 said core consumer prices rose 0.3 percent in March, the most in a year.
Andrew Harding, who oversees $16 billion in cash and bonds at Allegiant Asset Management in Cleveland, said in an interview last week the yield curve may reach 50 basis points this year. He is considering adding to his holdings of two-year notes.
``Even if in the committee's judgment the risks to its objectives are not entirely balanced, at some point in the future the committee may decide to take no action at one or more meetings in the interest of allowing more time to receive information relevant to the outlook,'' Bernanke said.
The Fed has raised its target rate by 3.75 percentage points to 4.75 percent. Interest-rate futures, or bets on where the Fed's rate may be in a particular month, show traders are certain policy makers will boost rates on May 10 to 5 percent. There is a 28 percent chance of another quarter-point increase by July, down from 64 percent on April 26, futures show. The odds of it reaching 5.25 percent in August are 52 percent.
Risk Compensation
Long-term securities typically yield more than short-term debt because investors want to be compensated for the risk that inflation accelerates over the life of the bond.
Over the past 20 years, 10-year Treasury yields exceeded two- year yields by an average of 88 basis points. The curve inverted for the first time since 2001 on Dec. 28, and two-year yields exceeded 10-year yields by as much as 16 basis points on Feb. 23 after the Fed raised its target rate by a quarter point to 4.50 percent and signaled more were on the way.
Michael Roberge, who oversees $40 billion as chief fixed- income officer at MFS Investments in Boston, said April 28 that the yield curve is about where it should be.
``The steepness of the curve now is fair,'' he said. ``We would become more concerned if the economy continues to grow pretty rapidly and the Fed prematurely goes on hold.''
Inflation Protection
First American's Kung said she's concerned high energy and commodity prices will seep into core inflation after reports last week showed consumer confidence and new and existing home sales all unexpectedly rose.
Yields on 10-year Treasury inflation-protected securities, or TIPS, declined more than those on regular Treasuries, as investors were willing to pay more for bonds that protect them against rising consumer prices.
The gap between yields on TIPS and regular Treasuries due in 2016 widened 6 basis points after Bernanke's testimony to as much as 2.68 percentage points, the highest since April 2005. The difference is the average inflation rate investors expect over the next decade.
``The market is beginning to price a Fed that may fall behind the curve,'' Dean Maki, chief U.S. economist at Barclays in New York wrote in the report. ``The risks in the near term are a continuation of this move with higher rates and a steeper curve as risk premium and increased inflation expectations are priced in.''
To contact the reporter on this story:
Deborah Finestone in New York at dfinestone@bloomberg.net;
Al Yoon in New York at ayoon@bloomberg.net.
Last Updated: April 30, 2006 11:
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