Strong housing data prompt bond sell-off

Strong housing data prompt bond sell-off
By Richard Beales and Michael Mackenzie in New York
Copyright The Financial Times Limited 2007
Published: May 24 2007 21:25 | Last updated: May 24 2007 21:25


Unexpectedly strong data on new home sales in the US hit Treasury bonds on Thursday, sending yields back to their highest levels of the year.

The sharp rise in yields underlined a three-month rising trend as bond investors have gradually discounted the likelihood of Federal Reserve rate cuts amid signs that US economic growth remains stronger than some had feared.

The yield on 10-year Treasuries on Thursday morning rose 5 basis points in New York to touch 4.90 per cent at one stage, a level last seen in January and matching the yields in August 2006.

Meanwhile, two-year yields also made headway towards 5 per cent, rising 4bp to 4.88 per cent. Yields on 30-year bonds broke above 5 per cent earlier in the week.

Thursday’s housing data revealed a 16 per cent year-on-year rise in new home sales and a drop in inventory in April.

“This piece of data combined with home completions at the lowest level in six years . . . suggests the supply overhang is finally starting to head south,” said Dimitry Fleming, economist at ING Financial Markets.

Meanwhile, average new home prices fell a record 11 per cent, as homebuilders tried to move stock amid slack demand.

“Some may see a silver lining here, as softer prices may also be helping the market clear, boosting transactions and reducing inventory,” said Alan Ruskin, chief international strategist at RBS Greenwich Capital.

Mounting evidence of sustained growth in the US – albeit at a lower level than in recent years – has damped investors’ hopes of rate cuts by the Fed this year.

“The bond market is selling off because there is a convergence towards a view that the Fed will do nothing for some time,” said Dominic Konstam, head of interest rate strategy at Credit Suisse. However, he said Treasury yields would probably continue to trade below the overnight Fed funds rate – currently at 5.25 per cent – because there were still questions over the health of the US consumer and the outlook for risky assets.

In March, when interest rate futures were pricing in at least two quarter-point rate cuts this year, the two-year Treasury yield stood at about 4.5 per cent. Now, interest futures markets are not pricing in a full 25bp cut until mid-2008.

The global rise in government bond yields has been even more pronounced in Europe, where robust economic growth is fuelling expectations of central bank interest rate rises.

The two-year German Schatz yield is up from 2.8 per cent at the start of last year to 4.3 per cent. The 10-year Bund yield has also been rising, narrowing the gap with US Treasury yields, and is near 4.4 per cent.