U.S. Treasuries posted their first quarterly loss since 2013 as fears of a Federal Reserve rate increase outweighed demand for safe-haven assets as Greece moved toward default. The yield on the 10-year Treasury note rose from under 1.85% in early April to nearly 2.50% (the highest level in 2015) in June before falling somewhat by quarter-end. (Bond prices and yields move in opposite directions.) U.S. gross domestic product contracted slightly in the first quarter, but a stronger-than-expected May jobs report and other gauges indicated that the economy was rebounding from the first quarter's weakness, adding to uncertainty about the timing of the Fed's first short-term rate hike since 2006.
The U.S. Treasury Long-Term Fund returned −8.52% in the quarter compared with −8.30% for the Barclays U.S. Long Treasury Bond Index and −3.94% for the Lipper General U.S. Treasury Funds Average. For the 12 months ended June 30, 2015, the fund returned 4.63% versus 6.33% for the Barclays U.S. Long Treasury Bond Index and 3.44% for the Lipper General U.S. Treasury Funds Average. The fund's average annual total returns were 4.63%, 5.40%, and 5.82% for the 1-, 5-, and 10-year periods, respectively, as of June 30, 2015. The fund's expense ratio was 0.52% as of its fiscal year ended May 31, 2014.
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The fund invests at least 85% of its assets in Treasuries but maintains small positions in securities backed by the U.S. government, including Treasury inflation protected securities (TIPS) and Ginnie Mae mortgage-backed securities (MBS). TIPS provide some inflation protection, while our MBS holdings provide added yield over Treasuries, decent liquidity, and diversification. The fund's duration, which measures its sensitivity to changes in interest rates, was slightly shorter relative to the benchmark, as we anticipate higher interest rates in light of the strengthening U.S. economy and a less accommodative Fed.
T. Rowe Price Chief U.S. Economist Alan Levenson expects the Fed's first rate increase by the end of 2015. But unlike the 2013 "taper tantrum" that ensued when the Fed first suggested the central bank could start winding down its monthly asset purchases, we don't anticipate a severe Treasury sell-off once the Fed begins increasing interest rates. While we expect the strengthening U.S. economy to put upward pressure on rates, recent dollar strength and muted inflation will likely continue to sustain strong demand for Treasuries and help keep a lid on U.S. yields. Large-scale quantitative easing efforts in Europe and Japan could also hold longer-term yields down globally by limiting the supply of high-quality government bonds. Finally, we expect that the pace of U.S. rate hikes will be gradual and the terminal rate fairly low compared with previous tightening cycles, giving investors time to adjust to the new environment.