U.S. Bond Yields Sink on Political Jitters

By Min Zeng Features Dow Jones Newswires

U.S. government bonds posted the biggest one-day rally in nearly a year Wednesday as U.S. political jitters drove investors into the bunker of haven assets.

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The 10-year Treasury yield settled at 2.216%, the lowest close since April 19, down from 2.329% Tuesday. Yields fall as bond prices rise.

It was the yield's biggest one-day slide since June 27, 2016 when investors rushed into the bunker of Treasury debt following the U.K.'s referendum to leave the European Union.

The yield premium investors demanded to hold the 10-year Treasury note relative to the two-year note fell to 0.96 percentage point, the lowest since late October. A shrinking premium is known in the bond world as a flattening yield curve, usually seen by investors as a sign of waning confidence in the U.S. economic outlook. Some investors say this is sending a note of caution to the Federal Reserve which is on track to raise short-term interest rates as soon as June.

Other haven assets also gained ground, ranging from German bunds, U.K. gilts, the Japanese yen and the Swiss franc. The U.S. dollar dropped nearly 2% against the yen, a large move for this liquid currency pair, underscoring investors' anxiety.

The catalyst for the latest round of flight to safety was a report late Tuesday that President Donald Trump allegedly asked then-FBI Director James Comey to back off the investigation of former national security adviser Michael Flynn, which prompted some members of Congress to call for further investigation. In a statement issued Tuesday evening, the White House denied the account.

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The development followed Mr. Trump's surprise decision a week ago to fire Mr. Comey. Investors are concerned that this political uncertainty is likely to make it more difficult for Mr. Trump to push through his ambitious agenda to stimulate economic growth.

"The window to get [fiscal stimulus] done is shrinking quickly," said Erik Weisman, chief economist and portfolio manager at MFS Investment Management.

Mr. Weisman said the big declines in Treasury yields suggest rising caution toward "the global reflation narrative" present in the market following Mr. Trump's election.

Mr. Trump's campaign promises of lower taxes, large infrastructure spending and lighter regulations have motivated investors to bet on stronger economic growth and higher inflation. The so-called Trump, or reflation, trade has been highlighted by investors selling Treasurys and buying securities such as stocks, corporate bonds, the dollar and emerging-market assets.

In essence, the allocation reflects investors' optimism that expansive fiscal policy would give the economy a strong boost at a time when the Federal Reserve has been tightening monetary policy and giving the economy less support than in recent years.

The bond market has been flagging a pullback of the Trump trade. After a big rise late last year, the 10-year Treasury yield has been falling this year. It was 2.446% at the end of 2016.

Some traders say Treasury yields are likely to post a steep drop if anxiety is heightened toward whether Mr. Trump might face impeachment. That could lead to a big selloff in stocks which set record highs this month.

"The worst case scenario of an actual impeachment, although still far-fetched, is picking up steam," said Anthony Cronin, a Treasury bond trader at Société Générale SA. "This brewing crisis is likely to keep a decent bid to Treasurys."

The question now is whether the political news out of D.C. might affect the Fed's tightening plan.

The labor market is approaching full employment, financial conditions remain loose, and the dollar has weakened, which give the Fed some room to tighten policy.

But market expectations toward a rate increase in June dialed back Wednesday. Fed-funds futures, used by investors to bet on the Fed's monetary-policy outlook, showed a 65% chance that the central bank would raise short term interest rates by its June 13-14 meeting, according to CME Group. The measurement was 74% on Tuesday and 88% a week earlier.

A June hike "could be derailed" if stocks in the U.S. or globally "have a dramatic price downturn," said Robert Schumacher, chief U.S. strategist and fixed income client portfolio manager at AXA Investment Managers.

Michael Lorizio, senior trader at Manulife Asset Management, cautioned that political risks are hard to predict and that it is "premature" to make a major asset allocation shift.

Mr. Lorizio said at the moment the political drama hasn't altered his assessment on U.S. growth prospects, adding that the nation's economic fundamentals remain solid.

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

(END) Dow Jones Newswires

May 17, 2017 16:13 ET (20:13 GMT)