Treasuries rose as the 9.8 percent unemployment rate, record low inflation and Europe’s deepening sovereign-debt crisis stoked demand for safety. Bonds returned 5.9 percent in 2010 after losing 3.7 percent in 2009, according to a Bank of America Merrill Lynch index. Treasuries pared their annual rally in December on bets the Federal Reserve’s asset purchases and an extension of tax cuts will revive the economy. The unemployment rate dropped in December for the first time in six months, according to economists before next week’s payrolls report. “We rallied as the recovery wasn’t happening as quickly as people were anticipating initially,” said Ian Lyngen, a government bond strategist at CRT Capital Group LLC in Stamford, Connecticut. “The pendulum of economic sentiment has started to shift back toward general optimism. The market is coming to the view that quantitative easing will be effective in stimulating the economy and inflation. Whether it does or not is a question.” The yield on the benchmark 10-year note dropped 54 basis points, or 0.54 percentage point, to 3.29 percent, according to Bloomberg generic data. The yield touched 2.33 percent on Oct. 8, the lowest level since January 2009. The two-year note yield fell by the same amount to 0.59 percent and dropped to a record low of 0.31 percent on Nov. 4. Bonds gained even as the government completed $2.2 trillion of note and bond auctions in 2010, surpassing the $2.1 trillion record set in the prior year. Debt in Custody Treasuries held in custody at the Fed for overseas accounts including foreign central banks advanced $430.1 billion to $2.616 trillion after increasing $486.8 billion in 2009 and $473.3 billion in 2008, the Fed reported this week. The 2010 increase was the smallest since 2007, when the debt in custody rose $70.3 billion to $1.226 trillion. U.S. debt advanced during the first three quarters on concern the economic recovery was stalling and nations such as Greece, Ireland and Portugal would default on their debt. “The European crisis exposed sovereigns that are worse off than we are, and Treasuries have benefited,” said John Fath, a principal at the investment firm BTG Pactual in New York, who helps manage $2.5 billion. Notes and bonds extended their rally after the Fed said following its Aug. 10 meeting that it would resume buying debt to support the recovery of the labor market and boost inflation to an acceptable rate. Corporate Returns Government debt returns for 2010 trailed the 9.5 percent reading for investment-grade corporate debt, according to Bank of America Merrill Lynch indexes. The S&P 500 Index advanced 13 percent, while IntercontinentalExchange Inc.’s Dollar Index gained 1.4 percent and the Reuters/Jefferies CRB Index of raw materials rose 17 percent. It was the first time since 2005 that stocks, bonds, commodities and the dollar all rose for the year. Bonds fell on Dec. 14 as the Fed announced after its policy meeting that the U.S. recovery is continuing and maintained a $600 billion second round of government debt purchases known as quantitative easing. Three days later President Barack Obama signed into law an extension of tax cuts enacted during the administration of his predecessor, George W. Bush. The U.S. economy expanded at a 2.6 percent annual rate in the third quarter, the Commerce Department reported Dec. 22. The revised increase in gross domestic product compared with a 2.5 percent estimate issued in November. Consumer Prices Consumer prices excluding food and energy rose 0.8 percent in November from a year earlier after an advance of 0.6 percent in the prior month, the smallest gain in year-over-year data going back to 1958, the Labor Department reported Dec. 15. U.S. employers added 140,000 jobs in December after an increase of 39,000 in the previous month, according to the median forecast of 61 economists in a Bloomberg News survey. The unemployment rate is expected to drop to 9.7 percent. The Labor Department’s payrolls report is due Jan. 7. “There are still big questions about the sustainability of economic growth we’ve seen that will have to be answered before yields move higher,” said Suvrat Prakash, an interest-rate strategist in New York at BNP Paribas SA, one of the 18 primary dealers that trade with the Fed. Traders are adding to bets that inflation will pick up. The difference between yields on 10-year notes and Treasury Inflation Protected Securities, a gauge of trader expectations for consumer prices over the life of the securities known as the break-even rate, has advanced to 2.28 percentage points, up from the 2010 low of 1.47 in August. The five-year average is 2.09 percentage points. Pimco’s View Pacific Investment Management Co., which runs the world’s biggest bond fund, raised in December its forecast for U.S. economic growth to a range of 3 percent to 3.5 percent in 2011, versus its previous estimate of 2 percent to 2.5 percent. The extra yield investors demand to hold 10-year notes over 2-year debt was at 2.70 percentage points after touching 2.89 percentage points on Dec. 15, the widest since Feb. 23. “Housing, lending and jobs have yet to recover, and while the banks appear to be loosening up the purse strings, they still have the benefit of a very steep yield curve to draw a safer earnings stream without the rigors of making loans,” Kevin Giddis, head of fixed-income sales, trading and research at brokerage firm Morgan Keegan Inc. in Memphis, Tennessee, wrote in a note to clients this week The 10-year note yield will decrease to 3.11 percent by March 31, according to a Bloomberg survey of analysts, with the most recent forecasts given the heaviest weightings. To contact the reporters on this story: Cordell Eddings in New York at ceddings@bloomberg.net; Daniel Kruger in New York at dkruger1@bloomberg.net To contact the editor responsible for this story: Robert Burgess at bburgess@bloomberg.net

Source