TREASURIES-U.S. bond market slides as Fed plans become clearer

Thu Jun 20, 2013 4:00pm EDT

* Market rout sends U.S. yields to highest in nearly 2 years
    * Higher yields might hurt housing, economic recovery
    * Fears about Fed ripple across credit market worldwide


    By Richard Leong
    NEW YORK, June 20 (Reuters) - Fears about the Federal
Reserve buying fewer bonds later this year pummeled the U.S.
bond market on Thursday, pushing benchmark yields to the highest
levels since August 2011, with few signs of when the month-long
rout will end.
    The sell-off in U.S. government debt has been swift and
dramatic. The iShares Barclays 20-year-plus exchange-traded fund
, one of the most popular bond ETFs, has lost about 10.7
percent during this period - comparable to a 1,500 point drop in
the Dow Jones industrial average.
    The surge in bond yields, should it continue, could hamper
the economic recovery the Fed is counting on to exit from the
unprecedented stimulus it has injected into the banking system
for over four years to grapple with the global credit crisis. 
    "We are in a regime shift in interest rates. The longer-term
shift in interest rates is higher," said Stephen Sachs, head of
capital markets with ProShare Advisors LLC in Bethesda,
Maryland. 
    The sell-off comes amid signs of tightening in other credit
markets, notably China, where the cost for banks to borrow from
one another hit record highs overnight. 
    The 10-year Treasury note's yield rose to 2.42 percent on
Thursday - highest since August 2011. Treasury yields are
benchmarks for mortgage rates and other long-term borrowing
costs. 
    This sudden leap in yields has raised worries that it will
unravel the housing rebound which has shown signs of gaining
traction, as sales of existing U.S. homes hit a three-and-a-half
year high in May, data released Thursday showed. 
    Anxiety about the end of near-interest-free money from the
Federal Reserve coming sooner than some traders had expected was
confirmed on Wednesday when Fed chief Ben Bernanke laid out the
blueprint for how and when the central bank will pare its $85
billion monthly purchases of Treasuries and mortgage-backed
securities.
    The surge in yields has roiled other credit markets here and
abroad. The turmoil brought new issuance to a halt in both
investment-grade and junk bonds, with investors and issuers
alike wary of the sharp spike in Treasury yields. 
    Perceptions in the market started to shift almost a month
ago when Bernanke broached the idea of reduced purchases. 
    The bond market selloff has been intense, with heavy trading
from a broad spectrum of investors from hedge funds to large
fund managers, and it has boosted mortgage rates to levels not
seen in a year. The TLT ETF saw its busiest day of trading since
May 2012, with more than 24 million shares traded by 3:30 p.m. 
(1930 GMT).
    Recent data that shown inflation falling below the Fed's 2
percent target, raising speculation that the signal from the Fed
on buying fewer bonds was premature, but Bernanke downplayed
these concerns at Wednesday's press conference. 
    The reaction in markets shows a re-appraisal of the
inflation outlook. Investors are more concerned now about
falling inflation rates, judging by the poor bidding at a $7
billion auction of 30-year Treasury Inflation-Protected
Securities on Thursday. 
    Inflation expectations as measured by the yield differential
between the nominal 10-year yield and the yield on 10-year
Treasury Inflation Protected Securities (TIPS) has fallen to
1.98 percent, lowest since December 2011.
    The Federal Open Market Committee, the Fed's policy-setting
group, offered a mild upgrade on the economy in its policy
statement after its two-day meeting on Wednesday, and Bernanke's
remarks at a press conference laid out the Fed's plans to cut
purchases soon. 
    Bernanke drew a distinction between less stimulus through
buying fewer bonds and tightening monetary policy via hiking
interest rates. That's a distinction the bond market does not
necessarily agree with, economists said. 
    "The reaction in markets to the Fed reflects the disconnect
over stock versus flow - the Fed likes to believe according to
its simplistic models that tapering isn't tightening, but of
course it is," said Julia Coronado, chief economist, North
America, at BNP Paribas. 
    The FOMC repeated that it will not raise interest rates
until unemployment hits 6.5 percent or lower, provided that the
outlook for inflation stays under 2.5 percent. The jobless rate
was 7.6 percent in May.
    On the open market, the benchmark 10-year Treasury note
 fell 12/32 point in price to 94-9/32, with a yield
of 2.401 percent, about 5 basis points up from late on
Wednesday. At one point the 10-year yield touched 2.471 percent,
the highest intraday level since August 2011, according to
Reuters.
    The 30-year bond was the day's worst performer.
The longest U.S. government debt maturity at one point down more
than 2 points in price with its yield climbing to 3.548 percent,
its highest level in about 22 months.
    The iShares iBoxx Investment Corporate Bond Fund, a popular
ETF, has lost 2.5 percent in two days to hit a 14-month low.
A couple walks along the rough surf during sunset at Oahu's North Shore, December 26, 2013. REUTERS/Kevin Lamarque

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