Treasury bond prices fell and yields rose as favorable economic data reduced their appeal as a perceived safe haven. Most forward-looking signals suggested that the U.S. recovery remained on track. Weekly jobless claims and the unemployment rate dropped to multiyear lows, while gauges of manufacturing and service sector activity were generally favorable. More data showed that the housing market had turned a long-awaited corner, as prices, sales, and construction activity all rose. Uncertainty over fiscal policy diminished, lessening a serious threat to the economy that had spurred investors to buy Treasuries and other low-risk assets. A vote to delay a confrontation over the federal government's statutory debt limit removed one source of uncertainty hanging over the economy and markets. However, lawmakers failed to reach a deal to avoid sequestration, a series of across-the-board federal spending cuts that took effect in March.
The U.S. Treasury Intermediate Fund returned 0.15% in the quarter compared with 0.15% for the Barclays U.S. 4−10 Year Treasury Bond Index and −0.80% for the Lipper General U.S. Treasury Funds Average. For the 12 months ended March 31, 2013, the fund returned 3.74% versus 4.11% for the Barclays U.S. 4−10 Year Treasury Bond Index and 4.91% for the Lipper General U.S. Treasury Funds Average. The fund's average annual total returns were 3.74%, 5.24%, and 4.80% for the 1-, 5-, and 10-year periods, respectively, as of March 31, 2013. The fund's expense ratio was 0.49% as of its fiscal year ended May 31, 2012.
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Benchmark Definitions
The fund invests at least 80% of its assets in Treasuries, but we take modest positions in non-benchmark securities backed by the U.S. government for their added yield potential and diversification benefits. Our out-of-benchmark allocation to agency mortgage-backed securities weighed on relative results but was more than offset by favorable security selection as our focus on higher-coupon securities lifted performance. Similarly, our allocation to Treasury inflation-protected securities, or TIPS, detracted from relative returns as inflation remained benign. Our focus on intermediate maturities, however, helped performance as real yields in this segment actually decreased in the quarter. The fund's duration, a gauge of its sensitivity to interest rate changes, was largely neutral versus the benchmark.
The U.S. economy appears to have rebounded in the first quarter. However, we anticipate midyear growth will lag the first quarter's pace as fiscal tightening takes its toll. We expect the impact of sequestration will be relatively short-lived, with growth picking up toward summer's end. T. Rowe Price economists project real gross domestic product growth of 2.0% and 3.0%, respectively, for calendar years 2013 and 2014. Risks to our forecast include a greater-than-expected impact resulting from federal spending cuts and tax increases that took effect in the first quarter, as well as flare-ups in Europe's debt crisis and slowing growth in China. On the other hand, pent-up private sector demand could provide a bigger-than-expected contribution to growth. Given these opposing scenarios, we expect intermediate- and long-term Treasury yields to remain range-bound in the near term. Over the longer term, we believe yields will rise from recent lows as global growth picks up and the U.S. economy strengthens.
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