Brian Edmonds Comments: Treasury Yield Curve Is Steepest Since February on Tax-Reduction Extension

December 18, 2010, Bloomberg

The extra yield Treasury investors demand to hold 10-year notes over 2-year securities touched the widest since February on speculation an extension of tax cuts will spur growth and increase deficits.

The benchmark 10-year yield rose this week to the highest level in seven months as retail sales advanced in November more than economists forecast and the Federal Reserve said the recovery is continuing. The U.S. economy grew at a faster pace in the third quarter, a report is forecast to show next week.

“The market will be subject to selling,” said Brian Edmonds, head of interest rates in New York at Cantor Fitzgerald LP, one of the 18 primary dealers that trade directly with the Fed. “It’s hard to think of anything good for bonds coming out of the tax-cut extension. Something has got to give.”

The difference in yield between 10- and 2-year notes increased for a third week, rising to 272 basis points yesterday, or 2.72 percentage points, from 268 basis points on Dec. 10, according to Bloomberg data. The spread touched 289 basis points on Dec. 15, the widest since Feb. 23.

Fed officials maintained following their Dec. 14 meeting a $600 billion program of U.S. debt buying under a second round of quantitative easing, saying the economic expansion hasn’t been strong enough to reduce joblessness. The recovery “is continuing, though at a rate that has been insufficient to bring down unemployment,” the Fed said in its statement.

The central bank bought Treasuries maturing from 2028 to 2040 yesterday, bringing the total in its latest purchase program to $129.7 billion, according to Bloomberg data. The Fed will hold two buybacks on Dec. 20.

Benchmark Note

The yield on the benchmark 10-year note was little changed at 3.326 percent yesterday, from 3.325 percent on Dec. 10, according to BGCantor Market Data. The 2.625 percent security maturing in November 2020 traded at 94 1/8.

The 10-year note yield touched 3.56 percent on Dec. 16, the highest level since May 13. A gain in two-year notes this week pushed the yield down three basis points to 0.61 percent. It touched 0.69 percent Dec. 13, the highest level since June 23.

President Barack Obama signed into law yesterday an $858 billion bill extending for two years all tax cuts enacted during the administration of George W. Bush. Congress passed the measure this week.

Retail sales gained 0.8 percent last month as Americans began holiday shopping, the Commerce Department reported Dec. 14. The median forecast of 77 economists in a Bloomberg News survey was for an increase of 0.6 percent.

U.S. Economic Growth

The U.S. economy grew 2.8 percent in the third quarter from a year earlier, faster than the 2.5 percent estimate issued last month, according to the median forecast of 61 economists before the Commerce Department’s report Dec. 22. Gross domestic wwwuct advanced 1.7 percent in the second quarter.

“The data has improved, and the tax package has contributed to the rise in yields,” said David Ader, head of government bond strategy at CRT Capital Group LLC in Stamford, Connecticut. “One needs to adjust what they were thinking next year to accommodate it.”

Bank of America Merrill Lynch’s MOVE index, which measures volatility in Treasuries based on prices of over-the-counter options maturing in 2 to 30 years, rose on Dec. 15 to 125.20, the highest level since September 2009.

Treasuries rallied over the past two days as yields near a seven-month high attracted investors.

The 10-year yield fell 20 basis points on Dec. 16-17, the most since a decrease of 22 basis points during the two days ended June 7, after the U.S. payrolls report showed employers added fewer jobs than forecast.

Relative Strength

The 14-day relative strength index on the 10-year yield was at 62 yesterday after increasing to 74.384 on Dec. 15, the highest since May 2009, according to Bloomberg data. Readings at or above 70 typically indicate yields are poised to fall.

Bonds rose yesterday as Moody’s Investors Service lowered Ireland’s credit rating five levels to Baa1 from Aa2. Moody’s also this week placed Greece’s Ba1 local and foreign currency government bond ratings on review for possible downgrade.

European Union leaders agreed to amend the bloc’s treaties to create a permanent crisis-management mechanism in 2013, with Germany refusing to boost the current 750 billion-euro ($1 trillion) emergency fund for the most indebted countries.

“There are still worries coming out of Europe that are lingering that are still supportive of the Treasury market,” said Jason Rogan, director of U.S. government trading in New York at Guggenheim Partners LLC, a brokerage for institutional investors. “The market will trade volatile and illiquid into the end of the year as people wind down their positions. The action should be very choppy.”