Treasury-market inflation bets rose to near a five-month high as traders forecast the Federal Reserve will increase bond purchases to spur the economy. The difference between yields on nominal 10-year Treasuries and equivalent inflation-linked securities, a gauge of price expectations known as the breakeven rate, widened as investors bet the Fed will be successful in sparking inflation. A sale of Treasury inflation protected securities, or TIPS, drew a negative yield for the first time at a U.S. debt auction yesterday. Mohamed A. El-Erian, chief executive officer at Pacific Investment Management Co., led analysts and investors who say so-called quantitative easing will drive up inflation. “Breakevens are a good way to play the QE trade,” said Sean Maloney, a fixed-income strategist at Nomura International Plc in London. “We don’t think this pattern is about to end, but it may become more volatile.” The yield on benchmark 10-year securities rose one basis point to 2.58 percent as of 9:59 a.m. in London, according to BGCantor Market Data. The 2.625 percent security due in August 2020 rose 3/32, or 94 cents per $1,000 face amount, to 100 13/32. Two-year notes yielded 0.37 percent, versus the record low of 0.327 percent set on Oct. 12. The difference between rates on 10-year notes and Treasury Inflation Protected Securities, a gauge of trader expectations for consumer prices, was at 2.17 percentage points, within one basis point of the most since May 19. A $10 billion sale of five-year TIPS drew a yield of negative 0.55 percent yesterday. ‘Rally’s Not Over’ The dollar traded near a 15-year low versus the yen on the outlook for Fed easing. The U.S. currency bought 81.01 yen, from as little as 80.41 yen yesterday, the weakest since April 1995. Treasuries still offer value, said Yusuke Tanaka, senior dealer for Mitsubishi UFJ Trust & Banking Corp. in Singapore, part of Japan’s largest publicly traded lender. “The economy’s not improving,” Tanaka said. “The rally’s not over.” He plans to buy 10-year notes at a yield of 2.7 percent, he said. Ten-year yields will be little changed at 2.57 percent by Dec. 31, according to a Bloomberg survey of banks and securities companies, with the most recent forecasts given the heaviest weightings. U.S. unemployment has been more than 9 percent since May 2009. Home-price gains slowed and consumer confidence rose, economists said before two industry reports today. The S&P/Case-Shiller home price index increased 2.1 percent in August from a year earlier, the smallest year-over-year gain since February, according to the median estimate of 27 economists surveyed by Bloomberg News. Auction Demand The U.S. is scheduled to auction $35 billion of two-year notes today, to be followed by sales of five-year debt tomorrow and seven-year securities on Oct. 28. The two-year notes yielded 0.38 percent in pre-auction trading, versus the prior record low of 0.441 percent at the previous auction on Sept. 27. Investors bid for 3.78 times the amount on offer last month, versus an average of 3.20 for the past 10 sales. Indirect bidders, the category of investors that includes foreign central banks, bought 39 percent of the notes, compared with the 10-sale average of 37.6 percent. Rising costs for metals, food and oil show the central bank is preventing deflation, John Brynjolfsson, chief investment officer at Aliso Viejo, California-based Armored Wolf LLC, said in an interview yesterday on Bloomberg Television. Deflation is a general drop in prices. Inflation ‘Bazooka’ “Their second goal is to achieve their target of 2 percent inflation,” he said. “The bazooka they have of quantitative easing should convince market participants that if that’s what they want, that’s what they’re going to get.” The UBS Bloomberg Constant Maturity Commodity Index was about 1 percent away from a two-year high. Fed Treasury purchases will spur global inflation while failing to bring down U.S. unemployment, El-Erian said yesterday. Pimco, based in Newport Beach, California, manages the world’s biggest bond fund. The central bank announced Aug. 10 that it will reinvest principal payments from its holdings of mortgage debt in U.S. government securities. It plans to buy Treasuries maturing from February 2021 to August 2040 today as part of that plan, according to its website. The Fed will probably add to its purchases at its next meeting Nov. 2-3, El-Erian said. The central bank “is terrified of deflation,” he said. Hoenig, who has dissented from every Fed policy decision this year, also criticized the strategy. “It is a very dangerous gamble,” Hoenig said in a speech yesterday in Lawrence, Kansas. “We risk the next crisis four or five years from now. Central bankers need to think of the long term.” To contact the reporters on this story: Matthew Brown in London at mbrown42@bloomberg.net; Wes Goodman in Singapore at wgoodman@bloomberg.net. To contact the editor responsible for this story: Daniel Tilles at dtilles@bloomberg.net

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