Strong payrolls could send rates to higher range

By Karen Brettell

NEW YORK (Reuters) – U.S. Treasury yields may head back into their highest trading range in almost a year if employment data on Friday is strong, after benchmark notes tested key technical levels amid a broad selloff on Thursday.

Ten-year note yields broke through support at 3.56 percent. If that level holds, debt would be pushed back into the trading range seen in early February, when yields rose to their highest level since April 2010.

Ten-year notes were last down 26/32 in price to yield 3.57 percent, up from 3.47 percent late Wednesday. They traded as high as 3.77 percent on February 9.

After retreating from recent highs in the last three weeks as turmoil in the Middle East and inflation fears sparked a safety bid, yields rose on Wednesday and Thursday as a surprisingly strong drop in first-time U.S. jobless claims and growth in the services sector added to bets the economy is growing at a robust pace.

“When there is news technicals don’t matter,” said Eric Green, chief economist and head of rates strategy at TD Securities in New York. “I would fully expect to be seeing the 10-year rising through 3.56 percent.”

The government’s release on Friday of February employment data will be a key event, he said, noting that Federal Reserve Chairman Ben Bernanke in congressional testimony this week said “the litmus test is going to be job growth. So if we get job growth at 250,000 and higher tomorrow, that’s going to build up the expectation that we’re at that point,” Green said.

The European Central Bank’s warning on Thursday that it may soon raise interest rates added to the bearish tone in U.S. government debt.

Five-year notes futures may also be vulnerable to weakness, as net longs in the contracts by non-commercial users, which includes hedge funds, have risen to their highest levels in more than two years, analysts at Nomura Securities said in a note on Thursday.

“While it is still possible for these traders to maintain a certain measure of net longs for an extended period, we feel that current levels are looking increasingly susceptible to a pull-back in the short-term,” Nomura analysts George Goncalves and Marcus Phua said in the note.

Five-year Treasury notes on Thursday fell 17/32 in price to yield 2.30 percent, up from 2.17 percent and breaking through yield support at 2.26 percent.

Even a strong payroll number on Friday, however, is no guarantee that Treasuries will continue to post losses, as Middle Eastern uncertainty remains and oil prices are vulnerable to further spikes.

Breakevens on Treasury Inflation-Protected Securities (TIPS) continued to rise on Thursday, indicating fears that oil prices could still move higher.

“The inflation curve seems to be pricing in some upside in oil from current levels,” said Sergey Bondarchuk, an interest rate strategist at BNP Paribas in New York. “The situation doesn’t seem to be contained, I think that is acting as brakes on this selloff.”

Five-year TIPS breakevens, which are a measure of the market’s inflation expectations, rose to 226 basis points on Thursday, the highest level since July 2008. Ten-year breakevens rose to 250 basis points, also the highest level since July 2008.

Long bonds, which dropped over a point in price on Thursday, remain the most vulnerable to further losses if economic momentum accelerates and if oil prices are contained.

“A pullback in oil prices and stronger economic data should put the long end under pressure here,” said Bondarchuk.

The bonds last traded down 1-5/32 in price to yield 4.64 percent, up from 4.56 percent on Wednesday.

(Additional reporting by Ellen Freilich; Editing by Leslie Adler)