U.S. Government Bonds Soften After Monday Rally

By Min Zeng 

        U.S. Treasury bonds pulled back after Monday's price rally that had sent the yield on the benchmark 10-year note to a two-month low.
        Investors took some chips off the table from the haven bond market as U.S. crude oil prices rebounded while China's stock markets strengthened after a recent selloff.
        In recent trading, the yield on the benchmark 10-year Treasury note was 2.177%, compared with 2.15% on Monday, according to Tradeweb. Yields rise as prices fall.
        The 10-year yield has dropped from 2.5% made in June, which was the highest intraday level since September. The yield is a benchmark to set long-term borrowing costs for U.S. consumers and businesses. It is also a key barometer for global investors and policy makers to gauge on the health of the economic and inflation outlook.
        Falling commodities prices and China's stock market turmoil have clouded the global economic outlook and boosted demand for ultrasafe U.S. government debt. Global uncertainty potentially complicates the Federal Reserve's plan to raise short-term interest rates for the first time since 2006.
        Fed officials signaled in their recent monetary policy meeting in late July that they were on course to step away from crisis-era monetary stimulus as their outlook for the labor market brightened. Traders said the door remains open to raise interest rates in the central bank's meeting in September, but many investors say the Fed may need to wait longer to assess the potential impact on the U.S. economy from weaker commodities.
        "Another leg lower in commodity prices does provide a marginal obstacle to the Fed's desired path of tightening, however the importance of getting policy rates off the zero bound remains a focus" of the Fed, said David Ader, head of U.S. government-bond strategy at CRT Capital Group LLC.
        Softer energy prices heightened concerns over China's economy while reducing U.S. inflation expectations. A stronger U.S. dollar driven by the Fed's pending shift into higher interest rates is hurting U.S. exports and lowered prices of imported goods. These factors make the Fed more difficult to push up inflation to its 2% target in the medium term.
        Some U.S. economic releases have been softening, raising questions over how robustly the economy is growing after a recent soft patch. On Monday, a gauge of the manufacturing sector pulled back. A gauge of wage inflation grew at the slowest pace since record began in 1982, a report on Friday said.
        With the Fed on data-dependent mode to decide the timing of the first rate increase, investors will continue to zero in on key data points including the non-farm employment report due Friday. Economists expect the U.S. economy has added 215,000 new jobs in July, following a net gain of 223,000 in June. The average hourly wage is forecast to have gained 0.2% last month after flat in June.
        "I think the Fed can still begin to lift the policy rate from emergency levels at a very slow pace without causing meltdown and panic," said Christopher Sullivan, who oversees $2.4 billion as chief investment officer at the United Nations Federal Credit Union in New York.
        Mr. Sullivan said the Fed's gradual and slow approach in the fresh tightening cycle would contain a rise in the 10-year Treasury yield.
        Investors have been charging a shrinking yield premium to hold longer-dated Treasury debt instead of shorter-dated noted over the past month. Money managers say the allocation away from shorter-dated notes and into longer-dated bonds suggests some concerns that with the global economy remaining sluggish, the Fed's tightening campaign, even on a measured pace, could hurt the U.S. economic outlook.
        The smaller yield spread is known as a flattening yield curve. Yields on shorter-dated notes are pinned to the Fed's key policy rate. Yields on longer-dated bonds are influenced by a variety of factors, especially the outlook for inflation which chips away bonds' fixed return over time.
        On Monday, the yield premium to hold the benchmark 10-year Tresury note instead of the two-year note fell to 1.485 percentage point, the lowest level since the end of April. The premium was recently at 1.493 percentage point on Tuesday.
        Write to Min Zeng at min.zeng@wsj.com
        (END) Dow Jones Newswires

        August 04, 2015 09:37 ET (13:37 GMT)

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