10-Year Note Yields Hold at Their Highest Levels Since December

(Bloomberg) -- U.S. Treasury 10-year note yields held near the highest in almost two months after government reports showed a drop in new unemployment claims and faster growth in labor costs.
The Labor Department data may bolster speculation that the Federal Reserve will raise interest rates at least once more. The 10-year note's yield, which moves inversely to its price, has surged in recent weeks amid signs the economy is recovering from a fourth-quarter slowdown.
``These are ugly numbers for bonds,'' said David Ader, an interest-rate strategist at Greenwich, Connecticut-based RBS Greenwich Capital, one of the 22 primary U.S. government securities dealers that trade with the Fed. ``I have been calling for 10-year yields to move back above 4.6 percent.''
The yield on the benchmark 10-year note was little changed at 4.56 percent at 12:10 p.m. in New York, according to Cantor Fitzgerald LP. The yield climbed about 20 basis points, or 0.20 percentage point, in the past two weeks and is the highest since Dec. 5. The price of the 4 1/2 percent note due in November was 99 91/6. The two-year note yields 4.57 percent, the highest in almost five years.
Treasuries briefly rose as benchmark stock indexes fell and on speculation the U.S. would raise the terror alert level. The U.S. has no plans to increase the alert, Homeland Security Department spokesman Russ Knocke said.
Yield Gap
Expectations that faster growth and inflation will cause the Fed to further increase its target for the overnight lending rate between banks has led traders to push yields on two-year notes above those of 10-year notes. Shorter-maturity debt is more sensitive than longer-maturity debt to changes in monetary policy.
The 10-year yield exceeded the two-year yield by 188 basis points when the Fed started lifting rates in June 2004. The central bank two days ago raised its benchmark rate to 4.5 percent, the highest since April 2001.
``We already had a pretty sizable selloff over the last week or so,'' said Alex Li, an interest-rate strategist at primary dealer Credit Suisse Securities USA LLC in New York. ``The market has more important data to worry about tomorrow, and also the auctions next week.''
Next week brings the government's quarterly auctions of three- and 10-year notes and 30-year bonds. The Treasury will sell $21 billion of three-year notes, $13 billion of 10-year notes and $14 billion of 30-year bonds in the first sale of 30- year debt since August 2001. The new 30-year bonds yielded 4.57 percent in pre-auction trading.
Claims, Productivity
First-time claims for unemployment insurance benefits unexpectedly fell last week and the number of Americans on unemployment benefit rolls dropped to the lowest level in almost five years, suggesting they are having greater success finding jobs.
Initial jobless claims dropped by 11,000 to 273,000, numbering fewer than 300,000 for a third straight week. Last year, claims numbered less than 300,000 just three times.
A separate Labor Department report showed productivity, a measure of how much an employee produces for each hour of work, fell at a 0.6 percent annual rate in the fourth quarter while the cost of labor per unit production increased 3.5 percent, adding to concern that rising wages and benefits may fuel inflation.
Economists at Bear Stearns & Co. said in a research report that the drop in productivity was connected to a slowdown in the economy last quarter. Growth in the last three months of year was 1.1 percent at an annual rate, the slowest since 2002.
Key Level
A drop in 10-year notes stalled when the yield reached 4.578 percent, the level at which the notes were first sold to investors in an auction in November.
``You're not going to find fresh sellers at lower prices with the risk of the number coming out tomorrow,'' said Thomas Tucci, head of U.S. Treasury trading at RBC Capital Markets Inc. in New York, the investment-banking arm of Canada's biggest lender.
Tomorrow's employment report is forecast to show U.S. employers added 250,000 workers to payrolls last month, compared with 108,000 jobs created in December and the most since January 2000, according to the median estimate of economists surveyed by Bloomberg News.
Traders are pricing in an 88 percent chance the Fed will raise its benchmark rate to 4.75 percent at its next meeting on March 28, up from 46 percent on Jan. 5, according to interest- rate futures. Traders raised bets on the odds of an increase at the following meeting on May 10 to 28 percent, from no chance at the end of last week.
Yield Curve
Bill Gross, who manages the world's biggest bond fund, said the difference between short- and long-maturity debt yields may steepen as overseas central banks trim purchases of notes maturing in 10 years or more.
Foreign central banks, which have kept long-term yields from rising even as the Fed raised rates, may have little reason to keep tying up assets for a longer period, Gross said.
Investors abroad owned about half the $4.18 trillion in tradable Treasuries as of December, according to Treasury data.
``The exploitation of higher yields on the longer end of the curve is basically over,'' Gross, chief investment officer of Pacific Investment Management Co., said in his February Investment Outlook, released yesterday. Foreign central banks ``have no incentive to disproportionately favor any maturity on the curve'' now that two- and 10-year yields are about even, he said.

To contact the reporter on this story:
Elizabeth Stanton in New York at estanton@bloomberg.net;
Joshua Krongold in New York at at jkrongold2@bloomberg.net.