Two-year notes risk higher yields on payrolls, Fed

By Karen Brettell

NEW YORK (Reuters) – Two-year notes may be among the Treasuries most at risk of a sell-off if employment data this week beats expectations.

A $35 billion auction of two-year notes priced with a one basis point tail on Monday, though traders said this may have been due to investors cleaning books ahead of quarter end.

A bigger risk to yields will be if data on Friday show that employers added more than the currently expected 190,000 jobs to their payrolls in March.

“We think there is a strong possibility of an upside surprise in payrolls, which will likely cause front-end yields to rise substantially,” analysts at JPMorgan said in a report.

Two-year notes were last down 2/32 in price to yield 0.78 percent, up from 0.74 percent late on Friday. They could be at risk as the Federal Reserve unwinds its stimulus program and paves the way for higher rates.


One reason two-year notes may be vulnerable is that the number of investors holding long positions in short-term Treasuries has increased, and the need to cover these positions in any sell-off may exacerbate market moves, said JPMorgan.

Futures data by the Commodity Futures Trading Commission indicates that long positions among “speculative” accounts, including hedge funds, are at four-month highs.

Mutual funds, meanwhile, appear concentrated in yield-curve-steepening trades, in which they are significantly long near-term maturities and short 10-year notes.

These trades are “an especially crowded position,” JPMorgan said. “If a large upside surprise were to occur, we would view front-end longs and curve-steepening positions as especially vulnerable in the current environment.”

History also shows that popular carry trades such as these have sold off the most when payrolls have beaten expectations.

On each of the last seven occasions since 2009 that payrolls have surprised to the upside, three-year and five-year Treasuries yields, which had the most carry trades, rose by an average 10 basis points that day, JPMorgan said.

So-called “red” Eurodollars, meanwhile, sold off an average of 15 basis points, wiping out nearly two months of carry.

These “red” contracts, which expire between June 2012 and March 2013, were among the worst performers on Monday. Futures that expire in March 2013 fell 7 ticks to 97.78, but saw technical support at around 97.76.


The expected end of the Fed’s quantitative easing program in June may also send short-term rates higher, analysts said.

Technical analysts at Credit Suisse view two-year notes as among the most at risk.

“Two-year U.S. yields may not be that far away from what should be a significant bearish break, which would not only clear the way for an outright sharp move higher, but also a significant flattening move,” analysts, including David Sneddon, said in a report.

“Although we have to see a break of key support, we are alert to this potentially occurring soon,” he added.

A break above the notes’ current yield support at around 0.86 percent to 0.90 percent could send yields swiftly to the 1.20 percent area, he said.

Five-year and seven-year notes also weakened ahead of planned auctions of the notes on Tuesday and Wednesday.

Five-year notes were down 6/32 in price to yield 2.20 percent, up from 2.16 percent, and seven-year notes fell 6/32 in price to yield 2.86 percent, up from 2.84 percent. Benchmark 10-year notes dropped 4/32 in price to yield 3.46 percent, up from 3.44 percent. (Editing by Dan Grebler)

Two-year notes risk higher yields on payrolls, Fed