Treasuries Drop; Yield Reaches 5% for First Time Since August

By Agnes Lovasz and Kevin Lim

June 7 (Bloomberg) -- Treasuries fell, pushing the 10-year note yield above 5 percent for the first time since August, after New Zealand unexpectedly raised interest rates, igniting concern that faster global economic growth may cause other central banks to boost borrowing costs.

Futures traders added to wagers for further increases by the European Central Bank after it lifted rates to a six-year high yesterday and reduced bets the Federal Reserve will need to lower borrowing costs this year. The Bank of England kept its target rate at 5.5 percent today, the highest since April 2001.

``Investors took fright at the New Zealand move,'' said Stuart Thomson, who manages 23 billion pounds ($45.7 billion) in bonds at Resolution Investment Management Ltd. in Glasgow, Scotland. ``Global growth is too strong, yields have to rise. The trend is bearish.''

Benchmark 10-year note yields rose 6 basis points to 5.03 percent at 7:50 a.m. in New York, according to Cantor Fitzgerald LP. The yield is the highest since July 28. The price of the 4 1/2 percent bond due May 2017 fell 1/2, or $5 per $1,000 face amount, to 96 28/32. Bond yields move inversely to prices. Two- year note yields rose 5 basis points to 5 percent.

U.K. bonds fell on speculation the Bank of England will raise rates again this year to counter inflation, with two-year gilt yields rising to 5.73 percent. Japanese 10-year yields rose to the highest since August. New Zealand and Australian two-year note yields climbed to the highest in seven years.

Fed Expectations

Traders see an 18 percent chance the Fed will lower its benchmark rate to 5 percent by year-end, compared with odds of 40 percent last week and 98 percent a month ago, according to Fed funds futures. The decline followed reports showing the services sector and employment grew at a faster-than-expected pace in May.

Fed policy makers have kept the overnight lending rate between banks at 5.25 percent at their last seven meetings. They will next decide on rates on June 28.

``Data coming out of the U.S. are strong and are pushing out rate-cut expectations to 2008,'' said Rachana Mehta, global bonds and currency strategist at DBS Asset Management Ltd. in Singapore. ``U.S. yields could go up some more, with the 10-year rising to about 5.1 percent'' in the next month.

Worldwide Slump

Bonds are falling worldwide on signs global growth will accelerate. The ECB yesterday raised rates to a six-year high of 4 percent, and New Zealand's central bank today lifted its benchmark to a record 8 percent.

``Economic growth globally is still good and interest rates may rise,'' said Chan Cheh Shin, who helps manage the equivalent of $325 million at APS Komaba Asset Management Ltd. in Singapore. Longer-dated Treasury yields will rise faster than those on short-term notes, he said.

ECB President Jean-Claude Trichet said yesterday interest rates in the 13 euro nations are still low enough to support economic growth. The ECB also raised its growth forecast for the euro-area economy to 2.6 percent this year, from 2.5 percent.

Yields also rose after Fed Bank of Richmond President Jeffrey Lacker said growth will rebound this year because of ``healthy'' consumer spending. Merrill Lynch & Co. and Goldman Sachs Group Inc. this week scrapped their forecasts that the Fed would cut interest rates this year.

``There's no point for the Fed to cut and that's bad for bonds,'' said Peter Schaffrik, a fixed-income strategist at Dresdner Kleinwort in London. ``That's haunting the market at the moment.''

The drop in Treasuries may be limited by speculation declines in stock markets will increase demand for the relative safety of government debt and as the climb in yields may attract some investors. Shares in the U.S. yesterday had their biggest two-day decline since March after first-quarter labor costs rose more than forecast.

``At around 5 percent, 10-year Treasuries are not looking expensive,'' said Michael Thomas, head of economics and strategy at ICAP Australia Ltd. in Sydney. ``I don't think there's pressure to sell off now unlike four weeks ago when yields were nearer 4.5 percent.''

Federal Reserve Governor Frederic Mishkin is due to appear at a House Financial Services Subcommittee hearing on consumer protection issues at 10 a.m. Washington time.