U.S. Government Bonds Yields Fall

By Min Zeng 

        Yields on benchmark 10-year U.S. government debt fell to a two-month low on Monday as a disappointing manufacturing report cast further doubt on the Federal Reserve's plan to raise interest rates as soon as September.
        Monday's decline in yields extends the bond market's price recovery from a selloff in the second quarter when the 10-year yield hit a nine-month peak. The yield logged the biggest monthly decline in July in six months. Yields fall as prices rise.
        U.S. bond funds and exchange-traded funds targeting Treasury debt have attracted net cash inflow for six consecutive weeks, the longest stretch since June 2012. In the Treasury futures market, the value of wagers investors place to bet on bond prices to rise further has risen to the highest level since April 2013, just one month before the bond market was rattled by the taper tantrum, or fears over a cutback from the Fed's bond-buying program.
        The bond market's turnaround comes as Fed officials and investors are grappling with sluggish global economic growth, subdued inflation and highly accommodative monetary policy around the globe. A recent flare-up of the Greek debt crisis, jitters about China and concern about what softening commodities markets mean for global growth have all boosted demand for ultrasafe U.S. government debt.
        Analysts point to solid U.S. employment as a factor that could allow the Fed to raise rates in September. Many investors say even a moderate increase by the Fed in its benchmark short-term interest rates could curtail U.S. growth as the economy has been recovering more slowly from the recent recession compared with precious cycles.
        "The environment of low inflation and subdued global growth remains a favorable backdrop for U.S. fixed income, despite the potential for the Fed tightening," said Erik Schiller, senior portfolio manager at Prudential Financial Inc.'s fixed-income unit, which has $560 billion in assets under management.
        Mr. Schiller said that if the Fed tightens into this backdrop, "it may be premature" and could help to slow the economy and lower inflation expectations. That is providing support to prices of longer-dated bonds, he said.
        The yield on the benchmark 10-year Treasury note fell to 2.173% Monday, compared with 2.207% Friday. The yield has fallen after rising to 2.5% in June, the highest intraday level since September.
        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 since 2006.
        The 10-year Treasury note yield is a key barometer for global investors and policy makers to gauge on the health of the economic and inflation outlook. The yield is a benchmark to set long-term borrowing costs for U.S. consumers and businesses.
        Falling commodities are complicating the Fed's tightening campaign, which have pushed U.S. inflation expectations lower. On Monday, U.S. crude-oil prices fell by more than 2%, approaching the lowest intraday level since 2009.
        A market-based gauge of 10-year U.S. inflation expectations in the Treasury bond market on Monday fell to the lowest level since March. The 10-year break-even rate, the yield spread between a 10-year Treasury note and a 10-year Treasury inflation protected security, was 1.71 percentage point on Monday.
        The level suggests that investors expect the U.S. inflation rate to be running at an annualized 1.71% on average within a decade. A month ago it was 1.91%.
        While the U.S. economy has strengthened in the second quarter after a recent soft patch, Monday's report showed the price index for personal-consumption expenditures, the Fed's preferred inflation measure, remained below the 2% target in June for 38th consecutive month. Inflation is a main threat to the value of longer-dated bonds.
        "Markets still see little inflation and investors continue to extend out the curve," meaning they are buying longer-dated bonds, said Richard Schlanger, a money manager at Pioneer Investments in Boston, which has more than $40 billion in assets under management.
        Mr. Schlanger said he has bought Treasury bonds over the past two months and cut holdings of corporate bonds.
        Investors put $393 million net cash in U.S.-based mutual funds and exchange-traded funds targeting the Treasury bond market for the week that ended July 29, according to fund-tracking company Lipper. It was the sixth consecutive weekly inflow for the sector, the longest stretch since June 2012.
        Investors including hedge funds and money managers have accumulated $6.56 billion in net long positions on the 10-year Treasury note futures, for the week that ended July 28, according to data from Cheng Chen, interest-rate strategist at TD Securities. It represents the biggest weekly net long since April 2013.
        A long bet wagers on prices of bonds to rise. The opposite is a short bet.
        Many money managers still expect the 10-year 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 ultra-loose monetary policy. But they expect the Fed's gradual approach to tightening and contained inflation to 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.
        Write to Min Zeng at min.zeng@wsj.com
        (END) Dow Jones Newswires

        August 03, 2015 12:07 ET (16:07 GMT)

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