Treasury curve warped by inflation, foreign demand
Tue Feb 22, 2005 09:52 AM ET
By Wayne Cole
NEW YORK, Feb 22 (Reuters) - Longer-term Treasury debt prices eased on Tuesday, with investors worried both by hints of incipient inflation and by signs foreign central banks might be losing their appetite for U.S. government debt.
The benchmark 10-year note (US10YT=RR: Quote, Profile, Research) slipped 2/32, so extending Friday's steep losses following a startling jump in core producer prices. Its yield rose to 4.27 percent from 4.26 percent late Friday and a low of 3.98 percent just two weeks ago when inflation seemed a distant threat.
The latest jolt came Monday when the central bank of South Korea said it would diversify more of its huge $200 billion in forex reserves, helping trigger a sharp slide in the dollar.
Treasury data show South Korea as a whole, including private investors, holds $69 billion in Treasuries -- a relatively minor amount for a $4.0 trillion market. However, traders fear South Korea could just be the thin end of the wedge and other central banks will follow.
"Korea really isn't that big a player in the Treasury market," noted Richard Gilhooly, fixed-income market strategist at BNP Paribas. "But it is one more central bank that's talking about looking for better returns. It shows the need for yield."
All together, foreign central banks hold $1.07 trillion in Treasuries, much of that held by Japan, and a trend toward diversification could at least sap their demand for new paper.
The timing of South Korea's announcement was also tricky for the market as Treasury holds an auction of new two-year paper on Thursday, likely to be worth $24 billion. Demand from indirect bidders, a class that includes foreign central banks, has been erratic this year and traders fear another low turnout.
Early Tuesday, the two-year note (US2YT=RR: Quote, Profile, Research) was holding at 3.44 percent, having earlier touch a fresh 34-month peak of 3.45 percent. Yields on the five-year note (US5YT=RR: Quote, Profile, Research) also held steady at 3.86 percent.
Selling was again concentrated in longer-term debt as investors unwound recent hefty curve-flattening trades. These bets had proved very profitable as long-term yields dived to two-year lows, but began to come unstuck last week after Federal Reserve Chairman Alan Greenspan implied the rally was overdone.
Since then investors have been selling longer-dated debt to unwind positions, leaving the 30-year bond (US30YT=RR: Quote, Profile, Research) down 14/32 in price on Tuesday. Its yield was up to 4.67 percent having risen from 4.65 percent on Friday and a trough of 4.35 percent earlier this month.
Still, traders felt this latest bout of curve steepening might not last past the U.S. consumer price report on Wednesday.
Analysts had been expecting a tolerable rise of 0.2 percent in the core CPI for January, but worried that risks were to the upside after a disconcerting 0.8 percent jump in core producer prices. A rise of 0.3 percent or more would likely stir speculation of a more aggressive monetary policy tightening path from the Fed, and thus hurt short-term debt.
Meanwhile, a benign rise of 0.2 percent or less would soothe fears of inflation and benefit longer-term paper.