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Friday the 13th turned out to be a horror story for those who have been betting against the Treasury market. Bond prices continued to rise, pushing the yield on the benchmark 10-year note down to its low of the year.
Treasuries extended their stealth advance amid an apparent increase in the aversion to risk evident in another weekly rise in the dollar, especially against the euro, amid growing expectations of some sort of restructuring of Greece's increasingly untenable debt. The stronger greenback, in turn, helped knock commodity prices lower and put other risk assets, notably stocks, on their back feet.
The newly auctioned Treasury 10-year note, the 3 1/8s of May 2021, ended the week at 3.17%, while the previous benchmark, the 3 5/8s of February 2021, wound up with a yield of 3.15%, unchanged from the previous Friday. That was the lowest level since the intraday nadir March 16, following the flight to quality after Japan's disastrous earthquake and tsunami, according to the Market Data Center at Barrons.com. It also was the lowest close for the 10-year note since Dec. 8 at 3.13%.
Last week's rally in Treasury prices and the resulting decline in yields came as a result of fundamental and technical factors. On the latter score, bond bears who had bet the other way apparently were scrambling to cover their short positions, reportedly buying Treasury-note futures to offset previous sales of call options on those contracts as a bearish bet on note prices.
As for the former, Treasury yields have moved lower in parallel with Dr. Copper, the commodity said to have a Ph.D. in economics for its ability to assess business conditions. Copper and the 10-year yield hit their recent peaks in mid-February, fell into mid-March, and rose to a lower high in mid-April. From there, both have declined in tandem to their 2011 lows. That's also consistent with the Economic Cycle Research Institute Leading Economic Index rolling over, which was noted by Joan McCullough, East Shore Partners' market maven.
ADDING TO THE MARKETS' disquiet is the ongoing Greek debt tragedy, which keeps getting worse. The European Union raised its forecast Friday of Greece's 2011 budget deficit to 9.5% of gross domestic product from the previous estimate of 7.4%, as the economy has fared even worse than expected under austerity, which has meant higher taxes and spending cuts. That also led to more civil unrest, including a general strike last week.
A Bloomberg poll of investors found 85% expected some sort of restructuring of Greece's debt. That is reflected in market prices of Greek government bonds, with two-year note yields exceeding 25%, which indicates the market doesn't expect debts to be paid as promised on time.
Ironically, the flight to the safety of Treasury debt comes as the U.S. government is about to reach its legal debt ceiling Monday. The federal government can finagle its way for another couple of months, while the White House and Congress wrangle over spending cuts demanded by the Republican-controlled House of Representatives as a condition for raising the debt ceiling.
The debt-ceiling kabuki ritual will play out without the U.S. government defaulting. Even if fiscal policy becomes less expansionary, the prospects for monetary policy seem to be the main drivers of the currency, commodity and Treasury markets. The Federal Reserve's QE2—the purchase of $600 billion of government notes—is slated to wind down by the end of June.
The bet had been that without QE2 to absorb the Treasury's prodigious borrowing, yields would have to rise. That seemingly reasonable expectation seems not to be playing out. Just as when the Fed wound up its first round of securities purchases a year ago, bond yields are declining while the economy shows signs of slowing.
E-mail: editors@barrons.com
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