December 13, 2010 / 5:55 AM / in 7 years

TREASURIES-Yields hit new highs, short paper catches fire

TOKYO, Dec 13 (Reuters) - U.S. Treasuries tumbled in Asia on Monday, driving up their 10-year yields to a new six-month high as Japanese investors kept dumping Treasuries on the spectre of higher growth and higher deficits in the United States.

The short end of the market is increasingly under pressure as the yield on two-year notes US2YT=RR also rose to a near six-month high and federal fund rate futures prices <0#FF:> started to price in the chance of a possible rate hike by the Federal Reserve in 2012.

That is a sea change from just over a week ago, when comments by Fed chief Ben Bernanke prompted debate among traders over whether the central bank will adopt another round of easing after its current $600 billion debt purchase programme expires next June.

The 10-year yield US10YT=RR rose to as high as 3.39 percent, from around 3.32 percent in late U.S. trade on Friday and breaking above a 61.3 percent retracement of its May-November fall at 3.37 percent that some market players had eyed.

U.S. T-bond futures prices TYv1 also broke a 61.8 percent retracement of their rally this year at 119-27.5/32 as the March futures fell 24.5/32 to 119-15/32.

“The fact that Treasuries have been sold quite often in Asian trade these days suggests that some Japanese investors are now eager to offload U.S. Treasuries as soon as possible,” said Tomoaki Shishido, a fixed-income analyst at Nomura Securities.

Japanese investors had bought a massive 22 trillion yen ($262 billion) of foreign bonds for the 27 straight weeks until November, a large part of them thought to be in Treasuries.

“Many investors are now saddled with unrealised losses, which points to strong pressure for more selling,” said a trader at a Japanese brokerage house.

The trader predicted the next target could be 3.68 percent in the 10-year yield, a 50 percent retracement of its fall to a low near 2.04 percent from a high around 5.33 percent set in 2007.

The two-year yield US2YT=RR also rose as high as 0.69 percent, its highest level since late June.

The January 2012 Fed fund futures contract fell 0.02 to 99.495, indicating a rate hike to 0.50 percent by then, though trade volume is thin in Asia.

A string of firm U.S. economic data, including a fall in jobless claims to two-year low, and a deal between President Barack Obama and Republican lawmakers to extend tax cuts and renew unemployment benefits have led to expectations of stronger U.S. growth next year.

A higher deficit could also undermine investors’ appetite for Treasuries, though market players do not expect Washington in the near term to face the kind of eroding investor confidence that some euro zone countries are now suffering.

Robert Ryan, an FX and interest rate strategist for Asia at BNP Paribas in Singapore, said the two-year yield is the key to gauging investors’ views on an economic rebound.

“Yes we have the 10-year going up but it’s the two-year we need to watch. What is sending the 10-year higher? Is it growth, inflation or credit (concerns)? So we prefer to focus on the two-year at this stage as the indicator of where this rebound is coming,” he said.

The sell-off in Treasuries has so far been led by the five- and 10-year sectors.

The yield curve between two- and 10-year yields has steepened to a level not seen since May, with the spread widening to 270 basis points.

“If the market really thinks there will be a rate hike within a year, then the two-year yield could rise near 1 percent. I don’t expect a rate hike that early myself but I cannot rule out the possibility of the market expecting that,” Nomura’s Shishido said. ($1=83.97 Yen) (Editing by Michael Watson)

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