Treasuries Set for Worst Year Since 1978 as U.S. Steps Up Sales

c.2009 Bloomberg News

Dec. 30 (Bloomberg) -- Treasuries headed for the worst year since at least 1978 as the U.S. stepped up debt sales to help spur growth in an economy recovering from its deepest recession in six decades.

U.S. seven-year notes were little changed before today's $32 billion sale of the securities, the last of three auctions this week totaling $118 billion. The Treasury sold a record- tying $42 billion of five-year securities yesterday and $44 billion in two-year notes on Dec. 28. U.S. government securities have fallen 3.6 percent this year, according to Bank of America Merrill Lynch indexes, the worst annual performance since at least 1978, when Merrill began collecting the data.

"It's the last hoop the market has to jump through in 2009," said James Collins, an interest-rate strategist in the futures group in Chicago at Citigroup Inc., one of 18 primary dealers obliged to participate in the Treasury's auctions. "Yields have been trending higher. It's been a response to increased supply."

The yield on the benchmark 10-year note was little changed at 3.80 percent at 9:24 a.m. in New York, according to BGCantor Market Data. The yield has increased 1.58 percentage points this year. The 3.375 percent debt due in November 2019 fell 1/32, or 31 cents per $1,000 face amount, to 96 17/32. The yield on a seven-year note was little changed at 3.31 percent.

President Barack Obama is borrowing unprecedented amounts for spending programs. U.S. marketable debt increased to a record $7.17 trillion in November from $5.80 trillion at the end of last year.

Record-Tying Sales

The last sale of seven-year notes, in November, drew a high yield of 2.835 percent and attracted bids for 2.76 times the amount on offer, compared with 2.65 times at the October offering. The seven-year security to be sold today yielded 3.35 percent in pre-auction trading.

"There's some attraction in yields, so it'll be another so-so auction," said Kazuaki Oh'e, a bond salesman in Tokyo at Canadian Imperial Bank of Commerce, the nation's No. 5 lender. "Investors are looking for more safety and less risk. It's easier to be safe going into the new year."

Yesterday's $42 billion five-year note sale drew a yield of 2.665 percent, compared with the forecast of 2.678 percent in a Bloomberg News survey. The bid-to-cover ratio was 2.59, compared with an average ratio of 2.36 times at the last 10 auctions. The two-year auction on Dec. 28 was weaker, drawing a yield of 1.089 percent, compared with a forecast of 1.059 in a Bloomberg survey. The bid-to-cover ratio was 2.91, the lowest since August.

'Grind Lower'

"With two auctions out of the way and the magic seven ahead of us, we believe that supply fears, which helped to get bonds into attractive levels, will fade for now and the next few days should be a steady grind lower in rates," said George Goncalves, chief fixed-income rates strategist in New York at Cantor Fitzgerald LP, a primary dealer.

Holders of U.S. debt have made a return of 81 percent over the past decade, according to the Bank of America Merrill Lynch indexes. That compares with an 8 percent loss for the Standard & Poor's 500 Total Return Index.

The Treasury yield curve, a barometer of the health of the U.S. economy, widened to a record earlier this month as investors bet an accelerating recovery will fuel inflation and hurt demand for the unprecedented sales of government debt.

Treasuries Versus Gilts

Treasuries are set for their first annual underperformance against U.K gilts since 2005 as the U.S. recovers at a faster pace than Britain. The U.K. economy contracted 0.2 percent in the third quarter while the U.S. expanded 2.2 percent. Gilts have fallen 1.9 percent this year, according to Bank of America Merrill Lynch data.

The gap between 2- and 10-year yields widened to a record 2.88 percentage points on Dec. 22, from 1.45 percentage points at the beginning of the year. The spread was at 2.71 percentage points today.

An index of home prices in 20 U.S. cities rose in October for a fifth consecutive month. The S&P/Case-Shiller home-price index increased 0.4 percent from the prior month on a seasonally adjusted basis, after a 0.2 percent rise in September. The gauge was down 7.3 percent from October 2008, the smallest year-over- year decline since October 2007.

U.S. Sentiment

Confidence among U.S. consumers rose in December for a second month. The New York-based Conference Board's consumer confidence index rose to 52.9 this month from 50.6 in November. The measure reached a record low 25.3 in February.

Fed Chairman Ben S. Bernanke has cited a tame inflation outlook as a reason for keeping the target interest rate for overnight loans between banks at a record low zero to 0.25 percent. Treasury Inflation Protected Securities, or TIPS, a gauge of trader expectations for consumer prices, show the improving economy may change sentiment and spark further bond declines.

The gap between yields on Treasuries and TIPS due in 10 years, a measure of the outlook for consumer prices, expanded to 2.43 percentage points yesterday, the widest since July 2008. It held at 2.40 percentage points today.

Related News and Information: Bond yield forecasts: ½BYFC ¾ Top bond market news: ½TOP BON ¾ World bond markets: ½WB ¾ Credit market watch: ½CMW ¾ Sovereign debt monitor: ½SOVR ¾ Credit crunch page: ½WWCC ¾ Short-term liquidity ½SLIQ ¾ Bonds for sale: ½PREL ¾

--With assistance from Theresa Barraclough in Tokyo. Editors: Dennis Fitzgerald

To contact the reporters on this story: Daniel Kruger in New York at +1-212-617-2986 or dkruger1bloomberg.net; Anchalee Worrachate in London at +44-20-7073-3403 or aworrachatebloomberg.net

To contact the editor responsible for this story: Robert Burgess at +1-212-617-2945 or rburgessbloomberg.net