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10-Year notes gain before new-home sales, GDP reports

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(Bloomberg) — Treasuries gained before reports that analysts said will show new-home sales slowed and gross domestic product contracted more than earlier estimated.

Two-year notes were little changed before the Treasury’s $30 billion sale of the securities today. They were yielding their highest since May 2011 in when-issued trading before the auction. A measure of Treasury volatility dropped yesterday to the lowest since May last year amid speculation an uneven U.S. economic recovery will prompt the Federal Reserve to keep interest rates low for longer.

“While the economic recovery in the U.S. appeared to be solid, the market is watching if that pace will be sustained in the second half of the year,” said Richard Kelly, a senior rates strategist at Toronto-Dominion Bank in London. “And the Fed has signaled it is not heading to the exit in a hurry. Expectation of low policy rate is going to keep bond yields well-anchored.”

Benchmark 10-year yields dropped three basis points, or 0.03 percentage point, to 2.60 percent at 7:03 a.m. New York time, according to Bloomberg Bond Trader data. The 2.5 percent note maturing in May 2024 climbed 9/32, or $2.81 per $1,000 face amount, to 99 5/32. The rate has increased from 2.48 percent at the end of last month.

Treasury trading volume fell to $192 billion yesterday, the lowest level since May 23 and a third daily decline, according to ICAP Plc, the largest inter-dealer broker of U.S. government debt. The average daily volume during the past year is $317 billion.

Pre-Auction Yield

The two-year notes scheduled for sale today yielded 0.50 percent in pre-auction trading, which would be the highest since an offering in May 2011 yielded 0.56 percent. The rate on the current two-year note was at 0.46 percent today. That’s below 0.49 percent forecast for the end of the second quarter by analysts in a Bloomberg survey.

Investors bid for 3.52 times the amount of notes on offer at a previous auction on May 27, compared with 3.35 in April. Indirect bidders, the category of investors that includes foreign central banks, purchased 18.9 percent, down from 23.4 percent. Direct bidders, non-primary-dealer investors that place their bids directly with the Treasury, purchased 25.2 percent. New home sales in the U.S. rose 1.4 percent last month after climbing 6.4 percent in April, a Bloomberg News survey of analysts showed before the Commerce Department report today. The U.S. economy shrank 1.8 percent in the first quarter, more than the initial reading of a 1 percent contraction on May 29, according to a separate survey before the data are released tomorrow.

Rate Outlook

There’s a 59 percent chance the Fed will raise its benchmark rate to at least 0.5 percent by July next year, based on fed funds futures yesterday, compared with a 43 percent probability at the end of last month.

Fed policy makers cut monthly debt purchases by $10 billion, to $35 billion, at their June 17-18 meeting, while leaving the target rate for overnight lending between banks in the range of zero to 0.25 percent, where it has been since December 2008.

Bank of America Merrill Lynch’s MOVE Index, which measures price swings based on options, declined to 54.59 basis points yesterday, the lowest since May 9, 2013.

The 10-year break-even rate, which measures the difference between yields on benchmark notes and similar-maturity Treasury Inflation Protected Securities, rose to 2.28 percentage points yesterday, the most since Jan. 13. The gauge, which represents the bond market’s forecast for the pace of consumer-price increases, has climbed from 2.21 at the end of May.

Preferred Gauge

Analysts said a report on Thursday will show the central bank’s preferred measure of inflation, the personal consumption expenditures price index, rose to the highest since October 2012.

The Fed’s 2 percent annual inflation goal is based on the PCE price index. The gauge increased to 1.8 percent last month, versus 1.6 percent in April, according to a Bloomberg survey before this week’s report.

“The auctions this week are going to add pressure to the front end of the curve,” said Shirley Tsai, a bond trader at Hontai Life Insurance Co. in Taipei “This week, the core PCE is going to be released and we expect this data to go higher. We also expect the 10-year break-even rate to go higher gradually.”

Philadelphia Fed President Charles Plosser will speak today in New York on the economic outlook and the monetary policy. New York Fed President William Dudley also speaks today.

The U.S. is selling $107 billion of coupon-bearing debt this week. It will offer $35 billion of five-year notes tomorrow and $29 billion of seven-year securities the following day. It will auction $13 billion of two-year floating-rate debt tomorrow.