<DIV id=above sizcache="15" sizset="0">Dec. 30, 2009, 10:30 a.m. EST
Treasury yields to rise in 2010, dealers say
Better economy making corporate bonds more attractive
<DIV id=mainstory sizcache="15" sizset="0">By
Deborah Levine, MarketWatch
NEW YORK (MarketWatch) -- Treasury bonds will fall next year, lifting yields as the economy slowly improves, giving investors one more reason to stay away from a sector which had its biggest annual loss in three decades in 2009, according to U.S. bond dealers.
Concerns about increasing government debt issuance will also lift yields, the MarketWatch survey of the 18 primary U.S. bond dealers found.
The U.S. government will see its borrowing costs rise from record lows hit earlier this year as investors favor investment-grade corporate debt.
Yields on 2-year notes, closely linked to the Federal Reserve's key interest rate, are seen rising to 1.26% by mid-2010 and 1.95% a year from now, according to analysts surveyed.
Primary dealers are required to bid at the government's auctions and trade directly with the U.S. central bank.
Some of the dealers surveyed believe the Fed could begin raising interest rates as early as June, while others expect it to keep borrowing costs on hold as long as until late 2011.
Yields on 10-year notes, the benchmark for a broad swath of debt including corporate bonds and mortgage rates, are expected to stay around 3.76% in the next six months, but end 2010 up near 4.16%, according to the survey.
On Wednesday, benchmark 10-year notes (U.S.:UST10Y) yielded 3.80%, while 2-year notes (U.S.:UST2YR) yielded 1.09%.
"There is every reason to expect Treasury rates to move higher," said Scot Johnson, senior client portfolio manager for Invesco Fixed Income. "If economic growth continues to improve as we've seen over the course of the year, and move farther from the threat of extended recession or depression, we expect to see Treasury rates move back more towards what we've seen historically."
Issuance risk
The biggest concern, and the one with the least uncertainty surrounding it, is that the government will issue even more debt in 2010, topping the record-shattering 2009.
Primary dealer Morgan Stanley expects the Treasury to sell $2.6 trillion in fiscal 2010, which began in October. That's a 40% increase year-over-year.
Not surprisingly, the firm has the highest forecast among dealers: predicting that 10-year notes will rise to 5.5% at the end of 2010.
Not only will the government have stimulus programs to fund, but the bond market will lose a huge buyer of U.S. securities in 2009: the Federal Reserve.
As part of its multi-front attack on the credit crisis, the U.S. central bank began in March buying Treasury securities on the open market. In all, it bought $300 billion, winding down the program in October with little fanfare and little shock to the bond market, analysts said.
Also, coming up in March the Fed will end its purchases of $1.425 trillion in mortgage-backed securities and debt sold by housing-finance agencies Fannie Mae (NYSE:FNM) , Freddie Mac (NYSE:FRE) and the Federal Home Loan Banks. Its purchases to date have had a much bigger impact on the mortgage-bond market, pushing many traditional investors into other fixed-income assets.
The completion of that program will also work to push Treasury rates up, some said.
"We expect yields to rise because, while we expect fixed income demand to remain high, the market will need to absorb a significantly greater amount of supply as the Fed asset purchases come to an end," said economists at primary dealer Barclays Capital.
Still, the rising tidal wave of debt issuance was expected to be a big problem in 2009, but ultimately all of the governments' auctions received more than enough demand, including from critically-important overseas buyers, to be completed without a hitch.
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