Treasuries Rise on Bernanke Forecasts, Subprime Mortgage Woes

The 10yr is challenging 5.00% again...


By Elizabeth Stanton and Daniel Kruger

Federal Reserve Chairman Ben S. Bernanke
July 18 (Bloomberg) -- Treasuries rose, pushing the benchmark 10-year note's yield below 5 percent, after Federal Reserve Chairman Ben S. Bernanke predicted inflation will recede and said housing market weakness may slow the economy.
The yield earlier rose as high as 5.06 percent on speculation Bernanke would emphasize the potential for inflation to accelerate. The Fed trimmed its forecasts for economic growth, and an index linked to the lowest-rated securities backed by subprime mortgages fell to a record.
``It's friendlier testimony than people expected,'' said Irene Tse, co-head of U.S. interest rates trading in New York at Goldman, Sachs & Co., one of the 21 primary U.S. government securities dealers that underwrite Treasury auctions. ``His view on inflation is somewhat moderated,'' and there is ``much larger emphasis'' on housing and subprime mortgages.
The benchmark 10-year note's yield fell almost 4 basis points, or 0.04 percentage point, to 5.01 percent at 4:05 p.m. in New York, according to Cantor Fitzgerald LP. The yield, which moves inversely to price, touched 4.99 percent, the lowest in a week. The price of 4 1/2 percent notes maturing in May 2017 rose 1/4, or $2.50 per $1,000 face amount, to 96 2/32.
Bernanke, in comments to the House Financial Services Committee today, said core inflation, which excludes food and energy prices, ``may be a better gauge than overall inflation of underlying inflation trends.'' Core inflation has slowed since February, while overall inflation has accelerated.
Fed Growth View
``This trend we've seen of core inflation abating and gradually diminishing is extremely constructive for intermediate and long-term interest rates,'' said Chris Molumphy, who oversees $150 billion as chief investment officer for fixed income at San Mateo, California-based Franklin Templeton Investments.
Labor Department data released today showed core prices rose 2.2 percent in June from a year earlier, the same rate as in May. Core inflation was 2.9 percent in September, the highest in 10 years. Including food and energy, prices rose 2.7 percent from a year earlier, more than forecast.
Federal Reserve policy makers left the target rate for overnight lending between banks unchanged for an eighth straight time on June 28, saying the potential for accelerating inflation was the biggest economic risk.
Bernanke said the Fed trimmed its forecast for U.S. economic growth this year to a range of 2.25 percent to 2.5 percent, from 2.5 percent to 3 percent, because of a slowdown in homebuilding. The forecast for next year was trimmed to 2.5 percent to 2.75 percent, from 2.75 percent to 3 percent.
A Commerce Department report released today showed permit issuance for new home construction slowed last month more than forecast to the lowest level in a decade, suggesting a recovery from the housing slump may not be quick.
Senate Testimony
Bernanke is scheduled to appear before the Senate Banking Committee tomorrow at 9:30 a.m. Washington time. The Fed chairman presents the central bank's outlook to lawmakers twice a year in February and July before taking their questions. Traditionally the prepared remarks are identical.
His last two semiannual testimonies also triggered Treasury market rallies. Ten-year note yields fell 7 basis points on Feb. 14 after he said ``inflation pressures are beginning to diminish.'' Last July 19, he said the Fed had to be mindful of ``the possible future effects of previous policy actions,'' triggering a drop of 8 basis points in the 10-year yield.
The yield is at the low end of its range over the past six weeks as losses in securities backed by subprime mortgages fueled demand for the safety of U.S. government debt.
Bear Stearns Losses
Bear Stearns Cos. yesterday told investors in two failed hedge funds it managed that their capital had been wiped out by ``unprecedented declines'' in the subprime mortgage-backed market. The ABX index linked to 20 subprime mortgage-backed securities rated BBB- and created in the second half of 2006 dropped 4.5 percent to 43 today, according to Deutsche Bank AG. It has fallen more than 50 percent since it started trading in January.
Bernanke said conditions in the subprime mortgage market ``have deteriorated significantly,'' reflecting the higher delinquency rates. Still, ``financing activity in the bond and business loan markets has remained fairly brisk,'' he said.
Treasuries that offer protection against inflation by indexing their principal to consumer prices outperformed regular Treasuries as consumer prices rose more than forecast last month. Prices increased 0.2 percent in June, compared with the median forecast of 0.1 percent among 78 economists polled by Bloomberg News.
`Not as Charming'
The yield on 10-year inflation-protected Treasuries declined more than 5 basis points to 2.64 percent. The gap between its yield and the comparable regular 10-year yield, investors' expectation of the average inflation rate over the life of the securities, increased to 2.43 percent, the highest in almost a month.
``The inflation outlook is not as charming as people like to think,'' said Gang Hu, head of inflation trading in New York at Deutsche Bank AG. Gains were limited because the government plans to sell 20-year inflation-linked bonds in an auction next week, he said.