Treasurys Rally Following Soft Inflation Data

By Sam Goldfarb Features Dow Jones Newswires

U.S. government bonds strengthened Friday, sending the yield on the 10-year note back toward 2.3%, as a new report showed softer-than-expected inflation.

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Excluding the often-volatile categories of food and energy, the consumer-price index rose just 0.1% in April from the previous month, the Labor Department said. That was below the 0.2% gain anticipated by economists surveyed by The Wall Street Journal.

While overall consumer prices rose 2.2% from a year earlier, the increase was 1.9% excluding food and energy, marking the first time the annual gain in core prices had been below 2% since October 2015.

In recent trading, the yield on the benchmark 10-year Treasury note was 2.329%, according to Tradeweb, compared with 2.400% Thursday and 2.352% a week ago. Yields fall when bond prices rise.

Debt investors keep a close eye on inflation because it is a main threat to bonds, eroding their fixed returns over time. Higher inflation also makes it easier for the Federal Reserve to raise interest rates, which diminishes the value of bonds by reducing money supply in the economy.

The modest rise in consumer prices last month followed an unexpected decline in March, which many investors had viewed as a one-off event.

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Fed officials, for their part, have expressed confidence that inflation will stabilize around their 2% target. The Fed's preferred measure of inflation is the Commerce Department's personal-consumption expenditures price index, which advanced 1.8% from a year earlier in March and tends to run below the consumer-price index.

Some economists believe it is only a matter of time before inflation settles at or surpasses the Fed's target, as the labor market tightens and employers are forced to pay workers more. Last month, the unemployment rate fell to its lowest level in a decade. Still, wage growth has been slow, and many bond investors have maintained a wait-and-see attitude toward inflation, preventing yields from rising higher.

The general view in the market is that "we are showing sub-2% inflation" and that means there is "probably going to be less Fed activity," said Sean Simko, head of fixed-income portfolio management at SEI.

Even after the consumer-price index report, many investors remained confident that the Fed will raise rates at its June 13-14 meeting, given strong signals from officials that they are ready to act again after last raising rates in March.

Fed-funds futures, used by investors to bet on the Federal Reserve interest-rate policy outlook, showed Friday 74% odds that the Fed would tighten monetary policy at its next meeting, according to CME Group.

Still, investors are cautious about predicting more rate increases, with an additional increase this year assigned just 50% odds.

Current bond yields reflect the ambivalence of investors. While the yield on the 10-year Treasury note has recovered from the five-month low of 2.177% it reached last month, it remains well the 2.6% level it briefly touched in March.

In recent weeks, investors have become less concerned about political risks overseas.

Many, though, are less optimistic than they once were about fiscal stimulus in the U.S. That has made it easier for them to buy Treasurys, given the diminished odds of faster economic growth, higher inflation and increased bond issuance that could accompany such policies.

Write to Sam Goldfarb at sam.goldfarb@wsj.com

(END) Dow Jones Newswires

May 12, 2017 13:00 ET (17:00 GMT)