U.S. Government Bonds Rally On Stock Declines

By Cynthia Lin 

        U.S. Treasurys were on the receiving end of a selloff in global equities Monday, though gains were held in check ahead of a Federal Reserve policy announcement.
        Benchmark 10-year notes gained 12/32 in price to yield 2.228%. Two-year notes rose 2/32 to yield 0.654%, while 30-year bonds advanced 20/32 to yield 2.939%. Bond yields decline when prices rise.
        Those gains came as equity markets in China suffered sharp declines, with the Shanghai Composite Index posting its worst daily percentage loss since February 2007. Concerns about stability in those markets put pressure on stocks in Europe and the U.S.
        "Treasurys got a bid right out the gate in response to the weaker equity prices, but keeping the market from rallying even more is the upcoming supply and the FOMC meeting," said Gary Pollack, head of fixed-income trading at Deutsche Bank's private wealth-management arm.
        Treasury prices slipped slightly from session highs midday as focus turned to a coming batch of U.S. government debt offerings, which typically weigh on bond prices. The Treasury is scheduled to sell a combined $90 billion in two-, five- and seven-year notes over the next three sessions.
        Also keeping some bond buyers at bay, the Federal Reserve kicks off its policy meeting Tuesday before releasing a statement on Wednesday. Although market participants don't expect the central bank to make any major policy changes, many say the statement could set the stage for a widely expected interest-rate increase this fall--which would mark the first rate rise in nearly a decade.
        "Global conditions are certainly far from ideal, but with Greek concerns resolved and only Chinese equity wobbles presenting a near-term challenge, the FOMC may sound more upbeat on rate hike prospects," said Gennadiy Goldberg, a U.S. strategist at TD Securities. He said that such a signal from the Fed could put further pressure on shorter-dated notes.
        In recent weeks, shorter maturities have lagged behind the gains in longer-dated Treasurys, compressing the so-called Treasury yield curve. Short-end notes are most vulnerable to the prospect of tighter monetary policy, while long-end Treasurys have benefited from the persistent lack of inflation.
        The latest round of weakness in commodities has worked against expectations for rising inflation. Oil prices fell again Monday to their lowest in four months.
        Inflation erodes the value of fixed-income payments over time, so represents a key threat to longer-dated bonds. Subdued inflation has therefore supported gains in longer-dated Treasurys. The yield on the 30-year bond slipped as far as 2.912% Monday, its lowest since June 1.
        In line with contained pricing pressures, inflation expectations reflected in the Treasury inflation-protected securities market have been on the decline. The yield between 10-year TIPS and nominal Treasurys shrank to 1.73 percentage point Monday, its lowest since mid-March and from 1.91 points at the start of the month.
        That reading implies bond investors expect a 1.73% average annual rate of inflation in the coming decade.
        Inflation remains a key missing ingredient to the Fed's ideal economic picture for raising rates. That, plus lingering global uncertainties and mixed U.S. economic data, could hold the Fed back from providing stronger hints Wednesday about its willingness to tighten policy this fall.
        Odds implied in the federal funds futures market suggested investors aren't fully convinced the Fed will pull the trigger on tighter policy come September. Contracts implied a mere 17% probability that the Fed raises its policy rate in September, and 52% chance for a move in December, according to data analyzed by the CME.
        Write to Cynthia Lin at cynthia.lin@wsj.com
        (END) Dow Jones Newswires

        July 27, 2015 16:27 ET (20:27 GMT)

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