Difference in US Treasury note yields narrows further

New York : The difference in yield between 2-year and 10-year Treasury notes narrowed for a fifth week as the Federal Reserve reiterated it would keep borrowing costs low for an "extended" period and reports showed a lack of inflation.

Two-year Treasury debt posted a third consecutive drop in the longest stretch of weekly decreases since August before record-tying $118 billion (Dh433.1 billion) sales this week of two-year, five-year and seven-year notes.

The yield on the two-year note increased to the highest level since January.

"With the Fed leaving the ‘extended period' language in place and benign inflation, investors are understanding that to pick up yield you have to go out the curve," said Larry Milstein, managing director of government and agency debt trading in New York at R.W. Pressprich & Company, a fixed-income broker and dealer for institutional investors.

"Supply has weighed on the front end. The big question this week will be supply and how the market absorbs it."

Yields on two-year notes increased last week three basis points, or 0.03 percentage point, to 0.9 per cent and touched 1 per cent, the highest level since January 8. The price of the 0.875 per cent security due in February 2012 dropped 2/32, or 63 cents per $1,000 face amount, to 99 25/32.

Yield flattening

The spread between 2-year and 10-year yields, charted on the yield curve, dropped on Thursday to 2.70 percentage points, the lowest level on a closing basis since January 1. The yield on the 10-year note was little changed at 3.69 per cent at the end of last week.

The last time the yield curve flattened for five consecutive weeks or more was in June 2005, when then Fed Chairman Alan Greenspan said in congressional testimony that underlying inflation remained "contained."

US consumer prices were unchanged last month, the first time prices had failed to increase since March 2009, the Labour Department said on Thursday.

Producer prices fell 0.6 per cent in February, the government said a day earlier. A lack of inflation helps preserve the purchasing power of debt's fixed payments.

The difference between yields on 10-year notes and Treasury Inflation Protected Securities, a gauge of expectations for inflation known as the breakeven rate, was 2.21 percentage points Friday, down from this year's high of 2.49 percentage points reached January 11.

"We expect inflation to remain contained for the rest of this year given the slack in the economy and the headwinds to growth," Curtis Arledge, chief investment officer of fixed income at New York-based BlackRock, wrote in a note to clients last week.

"We are more constructive on intermediate-to longer-dated Treasuries."

The Fed said in its statement following its meeting on March 16 that the economic recovery will be slow while repeating that its programme to buy $1.25 trillion of agency mortgage-backed securities and about $175 billion of agency debt will be completed by the end of March.

Futures on the CME Group exchange showed a 51 per cent chance that policy makers will increase the fed funds target by at least a quarter-percentage point by the September meeting, compared with 53 per cent odds a month ago.

The Fed may raise the discount rate, charged on direct loans to banks, before the next meeting of the Federal Open Market Committee on April 28, economists said. A Fed spokesman, David Skidmore, declined to comment last week.

"It's going to happen at some point," said Michael Feroli, chief US economist at JPMorgan Chase & Co. in New York.

"Whether it's today, whether it's next week or next month is hard to say."

US auctions

Demand for Treasuries was tempered as the United States prepared to sell a record-matching amount of two-year, five-year, and seven-year notes this week.

The government will offer $44 billion of 2012 debt on Tuesday, $42 billion in five-year notes the following day and $32 billion of 2017 securities on Thursday, the Treasury announced last Thursday.

President Barack Obama has increased US marketable debt to an unprecedented $7.41 trillion to fund a budget deficit the government predicts will swell to a record $1.6 trillion in the fiscal year ending September 30.

"Supply is certainly going to drive the market. There will have to be a bit of concession on the curve," said Thomas L. di Galoma, head of US rates trading at Guggenheim Partners in New York.

Benchmark 10-year securities snapped two weeks of losses as Greece's Prime Minister George Papandreou set a one-week deadline for the European Union to compile a rescue package before the nation goes to the International Monetary Fund.