U.S. 10-year yield reaches highest since 2011 on Fed speculation

(c) 2013, Bloomberg News.

NEW YORK — Treasury 10-year yields touched the highest level in more than two years as signs of a quickening economic recovery boosted speculation the Federal Reserve will keep reducing monthly debt purchases.

The benchmark yield rose above 3 percent for the first time in three months as investors weighed the Fed's decision last week to reinforce its commitment to low interest rates while starting to cut bond-buying in January. Citigroup Inc.'s Economic Surprise Index climbed Thursday to the highest since October, signaling an improving economy.

"Rates will be continually rising at a gradual pace," said Jennifer Vail, head of fixed-income research in Minneapolis at U.S. Bank Wealth Management, which oversees $112 billion. "As you see data prints that show the strength of the economy, that's how you'll see the upward drift in yields. We don't think rates will sell off aggressively from here."

The 10-year yield advanced two basis points, or 0.02 percentage point, to 3.01 percent at 2:32 p.m. New York time, according to Bloomberg Bond Trader prices. It rose three basis points earlier to 3.02 percent, the highest since July 26, 2011. The yield has climbed 12 basis points since Dec. 20 in its sixth straight weekly increase, the longest stretch in more than six months. The price of the 2.75 percent security due in November 2023 fell 1/8, or $1.25 per $1,000 face amount, to 97 26/32.

"People wanted to look at the other side of 3 percent and see if there were stop-loss orders" that would have propelled yields higher should investors have rushed to sell securities that had fallen in price, said William O'Donnell, head U.S. government-bond strategist at primary dealer RBS Securities Inc. in Stamford, Connecticut. Investors place stop-loss orders to automatically sell assets when a threshold is reached.

The two-year note yield fell two basis points to 0.39 percent. The security, which isn't included in the Fed's monthly program of asset buying, headed for a fifth weekly decline, the longest since September.

Treasury trading volume at ICAP Plc, the largest inter- dealer broker of U.S. government debt, slid to $72.7 billion Thursday, the lowest since Dec. 24, 2012. This year's daily average is $310 billion. Volume Friday rose to $111.8 billion as of 2:01 p.m. in New York

U.S. government securities have lost 3.3 percent this year, according to the Bloomberg U.S. Treasury Bond Index. That compares with a 0.3 percent loss by the Bank of America Merrill Lynch Global Broad Market Sovereign Plus Index.

The yield difference between 10-year Treasuries and comparable German government debt swelled to 109.8 basis points Thursday, the widest since 2006, as data shows the U.S. economy is accelerating faster than the euro region. The gap was 105 basis points Friday. It was 71.7 basis points on Oct. 22.

Treasuries traded at almost the cheapest level in more than two years, based on the term premium, a model that includes expectations for interest rates, growth and inflation. The gauge was at 0.62 percent, after reaching 0.63 percent on Sept. 5, the least expensive since May 2011, according to a Columbia Management model. The current reading is above the average of 0.21 percent over the past decade and shows investors see bonds as close to fairly valued.

The policy-setting Federal Open Market Committee said after its Dec. 17-18 policy meeting it will begin reducing its $85 billion of monthly asset purchases in January amid "growing underlying strength" in the economy.

The Fed will lower the buying in $10 billion increments over the next seven meetings before ending the program in December 2014, according to the median forecast in a Bloomberg survey of 41 economists on Dec. 19.

The odds of policy makers increasing their benchmark interest-rate target by January 2015 are 24 percent, based on data compiled by Bloomberg from futures contracts. The chance was 11 percent at the end of November.

The Fed said last week it "likely will be appropriate to maintain the current target range for the federal funds rate well past" its 6.5 percent jobless-rate threshold, especially if inflation stays below the Fed's 2 percent target. The benchmark rate has been in a range of zero to 0.25 percent since December 2008.

Increasing Treasury yields have driven mortgage rates higher even as 12 of the 17 FOMC members last week forecast policy tightening won't begin until 2015. Thirty-year fixed mortgage rates rose to 4.56 percent Thursday, the highest since Sept. 13, according to Bankrate.com.

"Slightly higher rates are unlikely to be enough to derail the housing-market recovery as improvement in labor markets and other economic fundamentals keeps the recovery on track," Gennadiy Goldberg, U.S. strategist at Toronto-Dominion Bank's TD Securities in New York, said in a Dec. 24 e-mail.

Citigroup Inc.'s Economic Surprise Index, which measures whether data surpasses or falls short of market expectations, rose to 49.4 Thursday, the highest level since Oct. 2.

Initial jobless claims fell by 42,000 to 338,000 in the week ended Dec. 21, the Labor Department said Thursday. Economists surveyed by Bloomberg predicted a decline to 345,000. The data followed reports on Dec. 24 that showed U.S. durable- goods orders rose in November more than forecast and new-home sales exceeded projections.

Inflation as measured by the personal-consumption- expenditures price index was 0.9 percent for the 12 months ended November, the Commerce Department said Dec. 23. The reading of 0.7 percent in October was the slowest in four years.

Treasury 10-year notes pay 1.77 percent after subtracting consumer price increases as a stronger economy pushes yields higher. The gauge of real yields has averaged 1.09 percent since December 2008.

Rates on Treasury one-month bills traded below zero amid rising demand for short-term debt at year-end. The rates were at negative 0.0051 percent for a second day.

_ With assistance from Daniel Kruger in New York and John Gittelsohn in Los Angeles.

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