George Goncalves Comments: U.S. Treasurys Gain As Bernanke Says Inflation Could Decline – Bloomberg News Online

Bloomberg News Online, December 8, 2009

Treasuries rose, with two-year notes gaining the most in more than five weeks, as Federal Reserve Chairman Ben S. Bernanke said the U.S. economy faces “significant headwinds” and inflation “could move lower.”

Yields on U.S. government securities fell as Bernanke said “credit remains tight” and the job market “remains weak.” The difference between 2- and 10-year yields reached the most since July before the U.S. sells $74 billion in notes and bonds in three auctions beginning tomorrow.

“The market is zooming in on that comment of the concept of inflation heading lower,” said George Goncalves, chief fixed-income rates strategist at Cantor Fitzgerald LP, one of 18 primary dealers that trade directly with the Fed. “The inflation comment is getting the market more comfortable with where yields are. We may see the market continue to rally here in front of supply.”

The benchmark two-year note yield fell seven basis points to 0.76 percent at 4:15 p.m. in New York, according to BGCantor Market Data. That’s the most since it fell nine basis points on Oct. 30. The 0.75 percent security due November 2011 rose 4/32, or $1.25 per $1,000 face amount, to 99 31/32.

The so-called yield curve rose three basis points to 2.67 percentage points, the most since July 27.

“We still have some way to go before we can be assured that the recovery will be self-sustaining,” Bernanke said. “My best guess at this point is that we will continue to see modest economic growth next year — sufficient to bring down the unemployment rate, but at a pace slower than we would like.”

Treasuries gained as Standard & Poor’s said Greece’s A- sovereign credit rating could be cut up to one notch to BBB+ if the ratings agency finds the government’s fiscal assumptions are “unrealistic.” S&P also said it may affirm the country’s rating if its fiscal plan is “aggressive enough.”

“The threat of Greece being downgraded is proving positive for bond prices,” said Thomas L. di Galoma, head of U.S. rates trading at Guggenheim Partners LLC, a New York-based brokerage for institutional investors. “The ratio of GDP to the amount of bonds outstanding is getting too high for a lot of these countries.”

Yields on government debt surged after the Labor Department reported on Dec. 4 that the unemployment rate fell to 10 percent and employers cut 11,000 jobs in November, compared with a median forecast of 125,000 positions in a Bloomberg survey. Fed policy makers meet next week to discuss interest rates and the economy.

‘Provide a Discount’

“People are looking for any hints of a change in the Fed’s outlook with response to timing and what will be said at the FOMC,” said William O’Donnell, U.S. government bond strategist at primary dealer RBS Securities Inc. in Stamford, Connecticut.

The Treasury will auction $40 billion of 3-year notes tomorrow, $21 billion of 10-year securities on Dec. 9 and $13 billion of 30-year bonds on Dec. 10.

“The market has backed off from extreme low levels over the last two weeks and that may provide a discount going into supply,” said Chris Ahrens, head of interest-rate strategy in Stamford, Connecticut at primary dealer UBS Securities LLC. The question is, will the central banks show up to buy Treasuries again? They have been pretty consistent in the marketplace so we don’t expect any real surprise here. The pullback in yields from Friday made it look attractive.”

At the government’s last sale of debt maturing in three years, a then-record $40 billion offering on Nov. 9, investors bid for 3.33 times the amount of securities offered, the most since at least 1993. Three-year note yields fell one basis point to 1.35 percent after the sale.

‘Failure to Commit’

“A strong result could mean a failure to commit to the duration of cheaper 10s, or a gamble the Fed talks down short rates at its upcoming meeting,” Jim Vogel, head of agency-debt research at FTN Financial in Memphis, Tennessee, wrote in a note to clients.

The Fed on Nov. 4 repeated it will keep interest rates near zero for “an extended period” and specified for the first time that policy will stay unchanged as long as inflation expectations are stable and unemployment fails to decline.

Federal-funds futures contracts on the Chicago Board of Trade show an 15 percent probability the Fed will increase the target rate to at least 0.5 percent by March, up from 11 percent odds a week ago. For an increase at the June meeting of the Federal Open Market Committee, the probability rose to 48 percent from 32 percent a week ago.