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Treasury Yields Rise on Lower Demand

A glut of Treasury borrowing - and the prospects of a better economy - could push rates higher in the next 12 months.

The yield on the bellwether 10-year Treasury note stood at 3.85 percent Friday, down from 3.89 percent Thursday but still at levels last seen in January.

Many managers say the Treasury's increased borrowing is pushing rates up. "It's mainly the amount of supply and the market's ability to absorb it," says Robert Auwaerter, head of fixed income at Vanguard, based in Valley Forge, Pa.

For example, the Treasury auctioned about $33 billion in seven-year T-notes on Thursday. Investor interest was surprisingly tepid: The Treasury got $2.61 in bids for every $1 of debt offered. The median yield - half were higher, half lower - was 3.29 percent.

In contrast, the Treasury got $2.98 in bids for every $1 of debt auctioned in February. Median yield: 3.05 percent.

Treasury investors had become too complacent, assuming that all auctions would go smoothly, and were shocked when last week's didn't, says Robert Gahagan, senior portfolio manager at the American Century funds in Kansas City, Mo. "It was like someone tapped the fish bowl and all the fish went to the other side."

The sheer number of auctions may be unnerving investors, too. The Treasury used to auction three-year, 10-year and 30-year Treasury securities every three months. Now the auctions are every month because of Treasury's big borrowing needs. "You just can't get away from these auctions," Auwaerter says.

An improving economy may also be driving rates higher. Yields typically fall when the economy is turning sour or when world events look dire. The 10-year T-note yield hit an all-time low of 2.07 percent in December 2008, at the height of the credit crisis.

Mortgage interest rates, which closely track the 10-year note, also could move up.

Earlier this year, investors foresaw a sluggish economy and low inflation, says Bob Whalen, principal at Tower Bridge Advisors in West Conshohocken, Pa. Now they're bracing for a stronger economy. That increases the chance of inflation and the possibility the Federal Reserve Board could raise short-term rates.

"The Fed doesn't usually raise rates until 12 months after unemployment peaks," Whalen says. "That means we'll see an increase in rates sometime before the end of the year." The unemployment rate hit 10.1 percent in October and 9.7 percent in February.

Whalen expects the 10-year T-note to yield 4.5 percent by year's end. Average 10-year T-note rate the past 10 years: 4.38 percent.

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