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Treasury Break-Even Rate Touches Three-Month High on Fed Outlook

June 20 (Bloomberg) -- A gauge of U.S. inflation expectations for the next 10 years touched the highest level in three months as the Federal Reserve maintains its commitment to low interest rates amid signs consumer prices are picking up.

Treasury five-year break-even rates were within one basis point of the highest since May 2013 after the Fed this week lowered the long-term estimate for its target interest rate. Ten-year notes headed for a third weekly drop before U.S. reports next week that analysts say will show home sales rose and confidence in the economy improved. A report earlier this week showed consumer prices in the U.S. accelerated at a faster pace than forecast by economists.

“We have had three upward surprises in U.S. CPI in the last three prints, and heightened geopolitical risk in Iraq pushing oil prices higher,” said Jorge Garayo, a fixed-income strategist at Societe Generale SA in London. “So it looks like finally we may be looking for inflation to move out of the recent low range.”

The 10-year break-even rate, which measures the difference between yields on benchmark notes and similar-maturity Treasury Inflation Protected Securities, was little changed at 2.24 percentage points at 6:55 a.m. New York time, after touching 2.25 percentage points, the highest since March 7.

The five-year rate was at 2.07 percentage points after reaching 2.08 yesterday, the most since May 13, 2013. Societe Generale recommends investors buy two-year U.S. index-linked bonds, according to Garayo.

‘Considerable Time’

U.S. index-linked bonds outperformed their German and U.K. peers this year. They returned 5.2 percent, according to Bank of America Merrill Lynch indexes, versus 2.9 percent for Germany’s securities and 3.9 percent for British linkers.

“Inflation has been surprising on the upside in the U.S., in contrast to the downside in Europe,” said Anton Heese, fixed-income strategist at Morgan Stanley in London. “The market is starting to price in a recovery in U.S. inflation trends, as the economy recovers.”

Fed Chair Janet Yellen and policy makers at their June 17-18 meeting cut monthly debt purchases by $10 billion to $35 billion, while leaving the target rate for overnight lending between banks in the range of zero to 0.25 percent, where it has been since December 2008.

Yellen brushed aside concern that inflation will quicken in her opening statement and press conference, emphasizing the Federal Open Market Committee’s view rates are likely to stay low for a “considerable time.”

Home Sales

The 10-year note yield was little changed at 2.63 percent, according to Bloomberg Bond Trader data. The price of the 2.5 percent note due in May 2024 was at 98 29/32. The yield has climbed two basis points this week.

Purchases of existing U.S. homes increased 1.7 percent in May, the fastest pace since July, according to a Bloomberg News survey before the National Association of Realtors releases the data on June 23. A measure of confidence among U.S. consumers rose to 83.5 in June, the most since a six-year high in March, a separate survey showed before the Conference Board report on June 24.

The U.S. government sold $7 billion of 30-year TIPS yesterday at a yield of 1.116 percent, versus the average forecast of 1.093 percent by seven of the Fed’s 22 primary dealers. The bid-to-cover ratio, which gauges demand by comparing the amount bid with the amount offered, was 2.76, up from 2.34 at the previous sale in February.

“It’s the inflation story -- clearly people are becoming more concerned about it and the Fed seemed to discount it,” said Larry Milstein, managing director in New York of government-debt trading at R.W. Pressprich & Co.

(An earlier version of this story was corrected to show Treasury prices were set for a third weekly decline.)

To contact the reporters on this story: Anchalee Worrachate in London at aworrachate@bloomberg.net; Candice Zachariahs in Sydney at czachariahs2@bloomberg.net To contact the editors responsible for this story: Paul Dobson at pdobson2@bloomberg.net Mark McCord

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