Treasuries slump on back of discount rate increase

New York: Treasuries fell, pushing yields to the highest levels in at least five weeks, amid concern the Federal Reserve's increase in the discount rate signalled policy makers are moving closer to lifting benchmark borrowing costs.

The difference in yield between two- and 10-year notes, known as the yield curve, touched a record high before the Fed raised the rate for direct loans to banks for the first time in more than three years. Several policymakers said the move doesn't portend changes in the outlook for monetary policy. The US will auction $126 billion (Dh462.6 billion) in notes and bonds this week.

"The fact is that we are past the banking crisis," said Thomas Tucci, head of US government bond trading in New York at the Royal Bank of Canada, one of the 18 primary dealers required to bid at Treasury auctions. "Now it's really about where people feel things are going where the Fed is concerned."

Increases

The 10-year note yield rose for a second week, increasing eight basis points, or 0.08 percentage point, to 3.77 per cent in New York, according to BGCantor Market Data. It touched 3.82 per cent Friday, the highest level since January 11. The 3.625 per cent security due in February 2020 declined 21/32, or $6.56 per $1,000 face amount, to 98 3/4.

The two-year note yield also gained for a second week, rising nine basis point to 0.92 per cent. It touched 0.96 per cent Friday, the highest since January 14.

The yield curve was at 2.86 percentage points Friday after steepening to a record 2.94 percentage points on February 18.

Inflation Below Forecast

Consumer prices increased 0.2 per cent last month, a Labour Dep-artment report Friday showed, falling short of a 0.3 per cent gain forecast in a Bloomberg survey.

The Fed said on February 18 it was increasing the discount rate to 0.75 per cent from 0.50 per cent to encourage financial institutions to rely less on the central bank for short-term borrowing.

Fed Chairman Ben Bernanke will probably assure Congress this week that a rise in the benchmark interest rate isn't imminent. Bernanke is scheduled to deliver his semi-annual report on the economy and interest rates to House and Senate panels February 24-25.

The discount rate increase is not a signal the Fed is prepared to tighten credit, New York Fed President William Dudley, a voting member of the rate-setting Federal Open Market Committee, said Friday.

Growth, jobs focus

"We got an inflation report that showed there's no inflation pressure," Dudley said after a speech in San Juan, Puerto Rico. "So our focus needs to be on growth and jobs."

Atlanta Fed President Dennis Lockhart and Fed Governor Elizabeth Duke also said in speeches last week the move doesn't signal a tightening of policy, and St Louis Fed President James Bullard said the central bank may not lift its benchmark rate until 2011.

The discount rate boost is a step in the Fed's retreat from its unprecedented actions to halt the deepest financial crisis since the Great Depression. The central bank has provided hundreds of billions of dollars in backstop credit to banks, bond dealers, commercial paper borrowers and troubled financial institutions such as American International Group Incorporated.

"The hike in the discount rate tells us absolutely nothing about the broader timing for a hike in the fed funds rate," Dan Greenhaus, chief economic strategist at Miller Tabak & Company in New York, wrote in a note to clients.

Funds lift

Futures contracts on the Chicago Board of Trade showed a 70 per cent probability Friday that the Fed will lift the federal funds rate, the target for overnight loans between banks, to at least 0.5 per cent by November. The odds were 65 per cent a day earlier. The rate has been in a range of zero to 0.25 per cent since December 2008.

Minutes released February 17 of the Fed's January policy meeting showed some policymakers pushed to start selling assets in the "near future".

Officials unanimously agreed the central bank's $2.26 trillion balance sheet will need to shrink "substantially over time" and return its holdings to just Treasuries.

"The Fed took extraordinary steps to get accommodation, and it's going to take extraordinary steps to reverse it," said Ward McCarthy, chief financial economist at primary dealer Jefferies & Company Incorporated in New York.

"It's a wake-up call that the exit strategy and the tightening of monetary policy that will come, still several months down the road, is not going to be a standard tightening."