Treasurys narrowly mixed; yield-curve flattens

AP News
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Posted: Dec 23, 2009 5:33 PM

Interest rates were little changed Wednesday as a surprisingly weak housing report halted a series of sharp drops in bond prices.

The Commerce Department report that new home sales plummeted 11 percent last month renewed investors' doubts about the strength of the economic recovery. A weaker recovery lessens the prospects of higher inflation that over time can hurt the value of bonds, and so the report quelled, for the moment, investors' questions about inflation.

Wednesday's quiet trading meant that the yield curve, a key benchmark that reflects the difference between the yields on two-year and 10-year Treasurys, narrowed slightly after setting records for two straight days.

But analysts expect bond prices to resume their slide, and yields to climb once more, because most signs point toward recovery and supply of new debt continues to grow.

The price of the 10-year note rose 2/32 to 96 29/32 in light trading Wednesday. Its yield fell to 3.75 percent from 3.76 percent late Tuesday.

The price of the two-year note fell 1/32 to 99 21/32. Its yield rose to 0.94 percent from 0.92 percent.

Michael Church, CEO at Addison Capital Group, said the yield curve is likely to steepen further because yields on long-term bonds are so unattractive right now. Short-term yields are likely to remain stable because they are heavily influenced by the Federal Reserve, which plans to hold its key interest rate steady.

"Who is a natural buyer of 30-years at 4.5 percent?" Church questioned. "No one really," he said answering his own question. The 30-year bond rose 3/32 to 96 6/32 on Wednesday. Its yield fell to 4.61 percent from 4.62 percent.

Banks were buying longer term Treasurys right now because they are tentative about lending money to consumers. However, as the economy recovers, they will be more likely to use that money to issue loans that provide better returns than government-backed bonds, Church said. While that will be good for the broader economy, it will cut even further into demand for bonds, likely sending their prices even lower.

Supply will further be an issue as the government continues to spend at record levels. The Treasury Department is scheduled to auction off 2-year, 5-year and 7-year notes next week.

The only way to entice buyers to return to the long-end of the market is to push yields higher. Before the recession hit, and when the stock market was at its peak in late 2007, the yield on the 10-year note was above 4.5 percent. The yield on the 30-year bond was approaching 5 percent.

In other trading, the yield on the three-month T-bill fell to 0.05 percent from 0.06 percent. Its discount rate was also 0.05 percent.

The cost of borrowing between banks rose slightly. The British Bankers' Association said the rate on three-month loans in dollars _ the London Interbank Offered Rate, or Libor _ increased to 0.2506 percent from 0.2488 percent.