U.S. 10-Year Bond Yield Falls to Three-Week Low On Tame Wage Inflation

By Min Zeng 

        A lackluster wage inflation gauge Friday clouded the Federal Reserve's plan to raise short-term interest rates as soon as September, energizing investors to pile into U.S. government bonds and sending yields tumbling broadly.
        The yield on the benchmark 10-year Treasury note dipped below 2.2% to a three-week low. The yield on the two-year note, among the most sensitive to changes in the Fed's interest rate outlook, pulled back from near the highest level of the year. Yields fall as prices rise.
        The 0.2% rise in the employment-cost index Friday was the smallest in three decades, pointing to sluggish wage inflation. The report underscores the challenges for the Fed to dial back crisis-era monetary policy amid sluggish global economic growth, subdued inflation and highly accommodative monetary policy around the globe.
        Weaker commodities this month have pushed down inflation expectations. A gauge of long-term U.S. inflation expectation has fallen this week to the lowest level since March. A stronger dollar is hurting U.S. exports while lowering prices of imported goods, making it difficult for the Fed to push inflation to its 2% target in the medium term.
        The report "is a red light for the Fed," said Jonathan Lewis, chief investment officer at Samson Capital Advisors LLC, which has $7.4 billion in assets under management. "This economic recovery is not strong enough to generate consistently positive economic data, let alone consistent upward pressure on wages."
        Mr. Lewis said he is skeptical the Fed can raise rates in September and added that Friday's report is "a green light for investors to move out of cash and into bonds."
        The yield on the benchmark 10-year Treasury note fell to 2.198% in recent trading compared with 2.268% on Thursday. The yield on the two-year note was 0.672%, compared with 0.731% on Thursday.
        Investors and traders say solid jobs growth still may allow the Fed to start raising rates in September. Fed Chairwoman Janet Yellen "has previously told us that wage growth is not a pre-condition for rate hikes," said Daniel Mulholland, senior U.S. Treasury trader at Credit Agricole in New York. "The Fed has told us they will be data dependent and there are two more payroll reports prior to" the Fed's next policy meeting in September, he said.
        The Fed's ultra-loose monetary policy following the 2008 financial crisis has sent prices of many stocks and bonds to elevated levels, raising concerns about whether financial assets could hold up once the Fed starts a tightening campaign for the first time in nearly a decade.
        The $12.7 trillion U.S. government debt market is crucial to not only the U.S. economic outlook but also to the health of global financial markets. The yield on the benchmark 10-year Treasury note is used to price a range of financing activities including mortgages, corporate bond supply and business loans.
        The 10-year yield fell this month for the first time since March after posing the biggest three-month rise in two years during the second quarter.
        While the 10-year yield has climbed after trading below 1.7% earlier this year, the yield remains very low from a historical standpoint. The 10-year yield last traded at 3% in early 2014. Before the financial crisis, the yield traded above 5%.
        Many money managers expect the yield to rise modestly during the balance of this year, seeing it as a normalization of the bond market in response to the Fed's shift away from ultraloose monetary policy. Few expects the 10-year yield to rise to 3% by the end of the year. Some investors say they would buy if the yield rises closer to that level.
        Investors say the Fed's gradual approach in tightening and contained inflation would keep a lid on a rise in the 10-year yield. U.S. bond yields are higher compared with their counterparts in many other developed countries, including Germany, Japan, the U.K. and France. A stronger dollar boosts foreign investors' investments in U.S. financial assets.
        "We might see a knee-jerk reaction to higher yields once the Fed starts raising rates, but without inflationary pressures the move is likely to be short lived," said Sean Simko, head of fixed-income management at SEI Investments which has $258 billion assets under management.
        Shorter-dated Treasury yields have risen this month as investors migrated money into longer-dated bonds to prepare for a potential rate increase in September.
        In the past three tightening cycles, the yield on the two-year Treasury note rose at a faster pace than the yield on the 10-year Treasury note. That is because shorter-dated bond yields are pinned by the Fed's short-term policy rate so they are more vulnerable to a shift in the Fed's policy.
        Investors say the central bank wouldn't want a repeat of the episode from the previous tightening cycle between 2004 and 2006, coined by former Fed chief Alan Greenspan as the bond market conundrum. Longer-dated Treasury yields only rose modestly during the rate-increase campaign, leaving financial conditions remaining relatively loose and sowing the seeds for the overheating housing market and the ensuing financial crisis in 2008.
        Unlike the past cycles, the Fed has tools this time to push up yields if needed, say analysts. One way, they say, is to signal to investors that they would sell their large holdings of Treasury debt accumulated through their bond-buying programs.
        Write to Min Zeng at min.zeng@wsj.com
        (END) Dow Jones Newswires

        July 31, 2015 11:26 ET (15:26 GMT)

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