By Karen Brettell and Richard Leong
NEW YORK, July 5 (Reuters) - A surprisingly strong jobs
report sparked heavy selling in U.S. bonds on Friday, sending
benchmark yields to two-year highs as investors reckoned the
economy might be growing just enough for the Federal Reserve to
trim its bond purchases later this year.
U.S. employers added 195,000 jobs in June while the
unemployment rate held steady at 7.6 percent as more people
entered the workforce, the Labor Department said.
There has been a growing view the central bank would reduce
its $85 billion monthly purchases of Treasuries and
mortgage-backed securities - the pillar of its third round of
quantitative easing, known as QE3 - as early as September if
domestic job creation remains at its current pace, which
averaged about 200,000 a month in the first half of the year.
'These numbers should support the notion the Fed might at
least announce its plan to taper in September,' said Mike
Cullinane, head of Treasuries trading at D.A. Davidson in St.
Petersburg, Florida. 'The market was clearly defensive going
into the (jobs) report.'
Investors have been dumping their bond holdings on worries
about the Fed shrinking its QE3 program and an inevitable
increase in short-term interest rates that would follow.
Rates futures implied traders expected the Fed to hike rates
in late 2014.
In the cash market, benchmark 10-year note yields have
climbed about 65 basis points since May 22 when remarks from Fed
Chairman Ben Bernanke before a congressional panel sowed worries
about reduced Fed bond purchases.
New Treasury supply next week may add to weakness in
Treasuries, while investors will also focus on the release of
minutes from the Fed's June meeting on Wednesday, traders said.
'I think from here going forward, buybacks and strength in
the market will be a selling opportunity,' said Dan Mulholland,
managing director in Treasuries trading at BNY Mellon in New
The Treasury Department will sell $66 billion in new debt
next week, including $32 billion in three-year notes on Tuesday,
$21 billion in 10-year notes on Wednesday and $13 billion in
30-year bonds on Thursday.
The 10-year notes last traded 1-19/32 lower in
price to yield 2.698 percent, up 20 basis points on the day for
its biggest one-day yield rise about two years.
Mortgage bonds suffered heavy losses too on anxiety that the
Fed would buy fewer of them. Thirty-year 3.0-percent coupon MBS
backed by mortgages guaranteed by Fannie Mae fell 2 points for a
yield of 3.95 percent, up 42 basis points from late Wednesday.
The U.S. bond market was closed Thursday for the July 4th
Independence Day holiday.
SIGNALS FROM TIPS, SWAPS SECTORS
A market signal that investors were prepared for reduced Fed
support in an improving economy occurred in the U.S. interest
rate swap sector.
The interest rate on 30-year dollar swaps briefly traded
above the yield on 30-year Treasury bonds during the
bond market sell-off.
The spread between the 30-year swap rate and the 30-year
bond yield was positive for a short time. This suggested traders
expected long-term private borrowing costs would rise faster
than those for the federal government as a strengthening economy
should boost tax receipts and reduce the amount of debt the
government needs to issue, analysts said.
The 30-year swap spread traded as wide as 1.25 basis points
shortly after the jobs data, a level not seen in 4-1/2 years,
before slipping back into negative territory late morning.
Another signal about an improving economy came from Treasury
Inflation Protected Securities. The yield spreads between TIPS
and regular Treasuries have rebounded since late June when they
contracted due to weak inflation data and worries about less Fed
The spread between 10-year TIPS and Treasury yields or the
10-year breakeven rate which the Fed monitors as a gauge of
investors' long-term inflation expectations moved to 2.07
percent, 3 basis points wider from late on Wednesday.
(Additional reporting by Karen Brettell and Luciana Lopez;
Editing by Kenneth Barry and James Dalgleish)
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