The first coordinated intervention in currency markets by the Group of Seven nations in more than a decade is combining with rising oil prices to end the biggest sell-off in Treasuries since the first half of 2009. After reaching a nine-month high of 2.19 percent on Feb. 8, yields on U.S. government debt fell to 2.04 percent on average last week, Bank of America Merrill Lynch’s U.S. Treasury Master index shows. The index has gained 1.47 percent in that period, compared with a loss of 4.18 percent in the prior four months. The rebound shows bond investors expect oil at more than $100 a barrel to temper economic growth at the same time developed nations from Germany to Japan sell yen and buy U.S. debt with the proceeds. Every $10 per barrel increase in crude cuts U.S. growth as much as 0.3 percentage point, UBS AG estimates. Japan will need to reinvest the estimated $25 billion in greenbacks acquired as it drove the yen lower on March 18 after the nation’s worst earthquake on record. “I don’t think the Treasury market has had the death spike put into it at this point,” said Mark MacQueen, a partner at Austin, Texas-based Sage Advisory Services Ltd., which oversees $9.5 billion. “The market’s extremely sensitive to perceptions of future economic growth. Any time that comes into question, the Treasury market’s the place to be.” Diminishing Expense Keeping yields contained will help taxpayers as the Treasury boosts borrowing to finance a budget deficit exceeding $1 trillion. Even though the U.S. sold more bonds in fiscal 2010 ending Sept. 30 than ever before, the interest expense fell to 2.7 percent of gross domestic product, from 3.1 percent the year before, and matched the lowest since before 1998, according to data compiled by Bloomberg. A financial model created by economists at the Fed that includes expectations for interest rates, growth and inflation suggests 10-year notes are fairly valued. The so-called term premium was 0.76 percent on March 25, compared with the 0.7 percent average over the past decade. The measure fell as low as negative 0.44 percent on Nov. 4, signaling Treasuries were expensive, the day after the Fed said it would conduct a second round of monetary easing through the purchase of U.S. bonds in a policy known as quantitative easing. “Our view has changed a lot over the last six months,” said Robert Tipp, chief investment strategist for fixed income in Newark, New Jersey, at Prudential Investment Management, which oversees more than $200 billion in bonds. “As Treasuries got toward the top of the range in the last month, yields have begun to look attractive.” Rising Yields The yield on the benchmark 10-year note rose 17 basis points, or 0.17 percentage point, last week to 3.44 percent in New York, according to Bloomberg Bond Trader prices. The price of the 3.625 percent security due February 2021 fell 1 1/2, or $15 per $1,000 face amount, to 101 1/2. Ten-year notes yielded 3.46 percent as of 1:44 p.m. in Tokyo. Last week’s losses came as concern eased that the nuclear crisis resulting from Japan’s earthquake and the military conflict in Libya will undermine the global economic recovery. Gains in Treasuries since Feb. 8 contrast with the view of Bill Gross, who runs the $237 billion Total Return Fund, the world’s biggest, at Newport Beach, California-based Pacific Investment Management Co. Gross said three weeks ago that he eliminated government-related debt from the flagship fund because investors aren’t being adequately compensated for the risk of inflation as oil and commodities surge. Rising Oil Crude oil hit a 30-month high of $106.95 a barrel on March 7, up from last year’s low of $64.24 in May, contributing to a 36 percent surge in commodities ranging from corn to cotton since August based on the Thomson Reuters/Jeffries CRB Index. Instead of causing a longer-term increase in inflation, higher oil prices may put a brake on U.S. growth and prices. Gasoline hovering at about the highest level since 2008 is straining finances of American households, whose spending makes up about 70 percent of the economy. As energy prices rose, the Labor Department said March 4 that average hourly earnings for Americans were unchanged in February. A $10-a-barrel increase in crude would “reduce growth by somewhere between 0.2 to 0.3 percentage point per year in each of the next two years,” said Drew Matus, a senior economist at UBS in New York. “It’s basically an overall impact on the economy, but obviously the main conduit through which it would act would be the U.S. consumer.” Consumer Confidence The Thomson Reuters/University of Michigan final index of consumer sentiment decreased to the lowest level since November 2009, the group said March 25. The Commerce Department in Washington said the same day that the U.S. economy grew at a 3.1 percent annual rate in the fourth quarter, up from its previous estimate of 2.8 percent last month. A bond market measure of inflation expectations the Federal Reserve uses to help determine monetary policy has declined to 2.82 percent from a 10-month high of 3.28 percent in December. The five-year five-year forward breakeven rate projects what the pace of consumer price increases may be beginning in 2016, smoothing blips in inflation expectations from swings in oil and other temporary events. Oil at $110 per barrel would be cause for concern, according to a Bloomberg News survey earlier this month of U.S. chief executive officers. Crude at that price would offset the benefit from the $858 billion tax cut extension approved by Congress in December, and slow growth, according to Chris Low, an economist at FTN Financial in New York. Fed Purchases The allure of Treasuries will diminish as the Fed finishes its bond purchases to flood the economy with cash and keeps its target rate for overnight loans between banks at a record low range of zero to 0.25 percent, Gross said March 11 in a Bloomberg Television interview. If U.S. gross domestic product increases at the 4 percent to 5 percent pace that the Fed expects, 10-year notes should yield about 4 percent, he said. Yields on 10-year notes aren’t forecast to reach that level until the first quarter of 2012, according to the median estimate of 55 forecasters in a Bloomberg News survey. The yield last touched 4 percent on April 5. The Group of Seven’s intervention to stem the surge in the yen after Japan’s earthquake may boost foreign purchases of Treasuries at this week’s auctions of $99 billion in 2-, 5- and 7-year notes, according to Bank of America Merrill Lynch strategists. An increase in foreign buying may reduce yields by about 20 basis points for every $100 billion of purchases, strategists Shyam Rajan and Priya Misra estimate. Custody Holdings The yen slid the most against the dollar in six months on March 18, when G-7 members sold the currency after it reached a post-World War II high of 76.25 per dollar, endangering Japan’s recovery. The yen had gained on speculation insurers and investors would sell foreign assets and repatriate funds to help pay for damage from Japan’s worst earthquake on record. G-7 central banks including the Bank of Japan sold about $25 billion of yen, the Bank of America strategists estimated. That compares with the Bank of Japan’s $23 billion intervention in September, a month when the Fed’s custody holdings of Treasuries surged by $104 billion, the largest increase since October 2008. “The G-7 countries and the three big central banks -- Japan, the U.S. and Europe -- stand ready to further act against this trend in a coordinated action,” Luxembourg Prime Minister Jean-Claude Juncker said March 23 in Luxembourg. During Japan’s intervention six months ago the yield on the 10-year Treasury dropped to 2.45 percent on Sept. 28 from 2.85 on Sept. 13. Japan’s holdings of Treasuries climbed by $28 billion, the biggest increase since June 2009. Concerns about Japan and the Middle East will continue to attract investors to U.S. government debt, said Jeffrey Caughron, associate partner in Oklahoma City at The Baker Group LP, which advises community banks on investing assets totaling $23 billion. “Treasuries still offer fair value in light of all the geopolitical risk.” To contact the reporters on this story: Susanne Walker in New York at swalker33@bloomberg.net Daniel Kruger in New York at dkruger1@bloomberg.net To contact the editor responsible for this story: Dave Liedtka at dliedtka@bloomberg.net

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