U.S. Treasuries Decline as Investors Abandon Rate-Cut Forecasts

June 11 (Bloomberg) U.S. Treasuries fell, adding to five weeks of losses, as Federal Reserve Bank of Cleveland President Sandra Pianalto said inflation is ``uncomfortably high.''
Fourteen of the 21 primary dealers that underwrite the government's debt, including Merrill Lynch & Co. and Goldman Sachs Group Inc., boosted their year-end estimate for the central bank's target rate or the 10-year note's yield after the Labor Department reported the economy added more jobs than forecast in May. Yields on 10-year notes exceed two-year securities by 15 basis points, the most since May 2006.
Investors have seen ``a transformation in terms of real yields and a reconfiguration of the yield curve,'' said Bill Gross, who manages Pacific Investment Management Co.'s $103 billion Total Return Fund. The Fed will continue to emphasize inflation risks, and a signal of ``all clear probably doesn't happen until 1.6 percent on the core'' inflation rate, he said.
The yield on the benchmark 10-year note rose 5 basis points, or 0.05 percentage point, to 5.16 percent at 9:04 a.m. in New York, according to bond broker Cantor Fitzgerald LP. The price of the 4 1/2 percent note due May 2017 fell 3/8, or $3.75 per $1,000 face amount, to 94 30/32. Yields move inversely to prices.
The two-year note yield gained almost 2 basis points to 5.01 percent.
`Uncomfortably High'
The Fed ``has described our core rate of inflation as being uncomfortably high and has stressed the importance of further moderation in inflation,'' Pianalto said today at a conference in Dublin. The Fed's Open Market Committee is likely to keep its target rate for overnight loans between banks at 5.25 percent when it meets on June 28, according to the median forecast in a Bloomberg News survey of economists.
The Commerce Department's price gauge tied to spending patterns and excluding food and energy costs rose 2 percent from April 2006, according to data released June 1. The index hasn't been below 2 percent since March 2004.
U.S. Treasuries underperformed their European peers. The extra yield that investors demand for holding the 10-year U.S. note over the equivalent maturity German bund rose to 59 basis points from 53 basis points on June 8.
`Market Is Fearful'
``The market is fearful that not only is the Fed not going to cut rates, but that it may have to raise rates,'' said Nick Stamenkovic, a strategist at RIA Capital Markets Ltd. in Edinburgh. ``The Treasury yield has further to rise. I think at least it will be 5.25 percent, if not 5.50, for the 10-year note before we see investors buying again.''
Options prices on fed funds futures on June 8 showed about 44 percent of investors are betting the Fed's benchmark rate will rise to 5.5 percent and 39 percent wagering on at least one cut by year-end. On May 1, they showed no expectations for an increase.
Fed policy makers kept the overnight lending rate between banks at 5.25 percent at their last seven meetings.
``The current levels actually present a good buying opportunity,'' said Dariusz Kowalczyk, chief investment officer at CFC Seymour Ltd. in Hong Kong. ``I don't think that the gains, especially at the long end of the curve, have been justified fundamentally, so in the medium term it's probably a very attractive level to jump back into the market.''
Fund managers who oversee $1.34 trillion said Treasury and agency securities fell to 26 percent of their holdings from 36 percent as of May 18, according to a survey by Ried Thunberg & Co., a Jersey City, New Jersey-based research firm.
``Ten-year yields at 5.25 percent would be too high,'' said Shun Totani, who helps manage about $600 million of non-Japanese bonds at Asahi Life Asset Management Co. in Tokyo. He bought 10- year Treasuries on June 8 and may add to his holdings should yields rise above 5.15 percent again.