Treasuries higher

Turmoil in the Middle East and North Africa and rising oil prices may send valuations on inflation-linked bonds still higher, after an oil spike on Wednesday caused investors to price in higher expectations that inflation will erode Treasury debt returns.
Treasury yields rose on Wednesday as stocks gained though yield increases were more than offset by a spike in inflation expectations after an air strike near some of Libya's oil infrastructure sent oil prices to near 2-1/2-year highs. Treasury Inflation-Protected Securities (TIPS), often referred to as "real yields" because they measure the value of the debt returns minus expected inflation, fell as investors worried about the effect of surging oil prices.
Five-year TIPS traded at around negative 52 basis points on Wednesday, and have rallied by around 10 basis points in the past week. Breakevens on five-year TIPS, which measures inflation expectations, rose to 221 basis points while 10-year TIPS breakevens increased to 245 basis points, the highest level since May of last year.
"There is still a lot of risk aversion, I think the big focus right now is what's going on with the Middle East, North Africa and oil," said Igor Cashyn, interest rate strategist at Morgan Stanley in New York. A decline in real yields is also typically a negative indicator for the economy.
"It's not good when real yields are rallying; if the economy is doing well you would expect to see real yields higher," Cashyn said. Treasuries have been volatile in recent weeks as bullish economic expectations, which have sent yields higher, have been offset by continued uncertainty in the Middle East.
"We really have a tug of war going on right now," said Jonathan Lewis, portfolio manager at Samson Capital Advisors, which manages over $7 billion in assets for clients including wealthy families, foundations, corporations and endowments. A highly anticipated US jobs report on Friday is expected to give further indications about the strength of the economic recovery.
The effect of surging oil prices is also muddying the picture as investors look for signs of when the Federal Reserve will remove economic stimulus, and in turn raise interest rates. An increase in rates will hurt the value of existing Treasuries, with intermediate-dated debt likely to fare worse. "We can't predict the exact moment when the Fed begins to raise rates, though it's going to be a long time off," said Samson's Lewis.
One strategy to take advantage of an expected rise in rates would be to enter a "barbell" trade, in which you purchase short and longer-dated debt, which will benefit from a flattening yield curve. "The belly of the curve will be hurt as the market begins to discount Fed tightening and therefore a barbell that avoids the three- and seven-year part of the curve is a better way to go," Lewis said. Benchmark 10-year Treasury notes were last down 18/32 in price, their yields rising to 3.46 percent from 3.40 percent late on Tuesday.
Two-year notes fell 2/32 in price to yield 0.69 percent, up from 0.65 percent on Tuesday, and five-year notes were down 8/32, their yields rising to 2.16 percent from 2.10 percent. Thirty-year bonds also declined 1-6/32 in price with yields rising to 4.55 percent form 4.48 percent on Tuesday.