U.S. Government Bonds Strengthen Ahead of France Vote

Features Dow Jones Newswires

y Min Zeng

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U.S. government bond prices gained ground Friday following a two-day slide as some investors sought comfort in haven assets ahead of Sunday's presidential voting in France.

The yield on the benchmark 10-year Treasury note settled at 2.234%, compared with 2.239% Thursday. Yields fall as bond prices rise.

The yield had fallen to 2.209% earlier Friday, near a five-month low set on Tuesday.

The bond market's mild price gains suggest there isn't a high level of anxiety. The Dow Jones Industrial Average was little changed while government bond yields in France rose slightly after sliding earlier this week.

"The race is neck to neck, so anything could happen," Andrew Pace, vice president at Performance Trust Capital Partners LLC, said of the French presidential contest. "It may be wise not to place big bets one way or another" ahead of the weekend.

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Oil prices provided another boost for bonds. U.S. crude futures fell below $50 on Friday and suffered a 7.4% loss this week. Lower energy prices reduce investors' worries over inflation, a main threat to the value of long-term government bonds. Higher inflation erodes investors' purchasing power from income earned from their bond investments.

The yield premium investors demanded to hold the 10-year Treasury note relative to the 10-year Treasury inflation-protected security, known as the 10-year break-even rate, fell to 1.84 percentage point Friday. That was the lowest since Nov. 8, the U.S. election day when it traded at 1.728 percentage point.

At its recent level, the break-even rate suggests investors' expectations of 1.84% annualized inflation rate over the next 10 years, moving below the Federal Reserve's 2% target again.

A shrinking break-even rate means investors are paring back the inflation trade that had gained momentum after Donald Trump was elected president. In doing so, investors sell TIPS and buy back Treasury debt.

The big focus for global markets near term is the first round of the French elections on Sunday. If no candidate wins an outright majority, a runoff between the top two candidates will be held in early May.

Polls this week showed Emmanuel Macron, a pro-European former economy minister, maintaining a lead. But analysts said the results are too close to call in one of the most unpredictable races in recent history.

Right-wing candidate Marine Le Pen has advocated for France's departure from the eurozone. France is the second-largest economy in the eurozone, raising concerns among investors that an exit could lead to a collapse of the monetary union.

A late surge in support for left-wing candidate Jean-Luc Melenchon, who also runs an anti-Europe platform, further complicates the outcome.

The biggest risk for investors, traders said, is that Mr. Melenchon and Ms. Le Pen enter the second round.

"If there is any upset, we would have an ugly Monday," said Marc Bushallow, managing director of fixed income at Manning & Napier. "There would be flight to safety at least in the short term."

Demand for haven bonds would likely retreat if Mr. Macron, a centrist, prevails in the first round.

Blake Gwinn, U.S. rates strategist at Natwest Markets, said a large selloff in Treasury debt is unlikely given the uncertainty surrounding the second-round race.

Andy Chorlton, head of U.S. multisector fixed income at Schroders, said it is "imprudent" to place big bets in financial markets either way ahead of Sunday's voting.

U.S. government bond yields have sunk over the past weeks after a recent rise. The 10-year yield traded above 2.6% in mid-March.

The shift has been driven by a confluence of factors including geopolitical tensions over North Korea and Syria as well as political risks in Europe, and a number of disappointing economic releases this month that raised questions about the momentum in U.S. economic growth.

On top of that, the Trump trade -- betting on stronger growth and higher inflation driven by the prospect of large fiscal stimulus -- has been retreating.

Bets on higher bond yields, or shorts, have been diminishing over the past weeks. Investors unwinding these bets return to the bond market as buyers, driving yields lower.

Write to Min Zeng at min.zeng@wsj.com

(END) Dow Jones Newswires

April 21, 2017 16:10 ET (20:10 GMT)