U.S. Government Bonds Stronger on Fed Signals

By Min Zeng Features Dow Jones Newswires

The U.S. government bond market strengthened Thursday for a second consecutive session, as investors continued to cheer on the Federal Reserve's signals that its tightening campaign would continue to proceed in a slow manner to avoid rattling markets.

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In recent trading, the yield on the benchmark 10-year Treasury note was 2.250%, according to Tradeweb, compared with 2.266% Wednesday. Yields fall as bond prices rise.

The Bank of America Merrill Lynch MOVE index, which measures implied Treasury bond price swings based on options, pointed to subdued expectation over price swings. The index settled at 54.4058 Wednesday, the lowest level since Aug 2014, another sign the Fed minutes released Wednesday afternoon reduced fears over a big rise in yields.

A lower reading suggests investors expect smaller price swings or a relatively tight trading band for yields.

The bond market faces $28 billion sale of seven-year notes at 1 p.m. Thursday, the last leg of this week's new Treasury debt offerings. This factor contained the declines in bond yields. Some bond traders expect decent demand, given that the two-year and five-year note sales earlier this week drew solid buying.

The Fed's minutes for its May 2-3 policy meeting suggest the central bank is on track to raise short-term interest rates next month. But officials signaled they may hold steady if economic conditions don't warrant a move so soon.

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In addition, Fed officials suggested a slow and predictable manner when they start the process of winding down its large balance sheet which includes more than $2 trillion worth of Treasury bondholdings.

Traders and money managers say the release reassures investors that the central bank would try to avoid a repeat of the "taper tantrum". U.S. Treasury bond yields soared in 2013 as fears that the Fed would soon dial back bond buying spook sentiment. Higher yields rippled broadly into corporate debt and emerging markets, causing a record pace of outflows from bond funds, tightening financial conditions and undercutting the U.S. growth momentum.

"The risk of another taper tantrum is fairly low," said John Bellows, portfolio manager at Western Asset Management Co. "The Fed doesn't want to disrupt the economic recovery. The Fed doesn't want to disrupt markets."

The 10-year Treasury yield has fallen this year after a big rise in late 2016. The yield traded at 2.446% at the end of 2016. In mid-March, it had traded above 2.6%.

Lower Treasury yields are encouraging some investors to dial up risk spectrum in a bid to get more income. The S&P 500 index reached a fresh record high Thursday, deepening its rally this year.

Lower bond yields also reflect a camp of thoughts in the bond market that after a possible hike in June, the Fed may stand pat for the rest of the year, say some analysts.

This explained why the bond market didn't sell off even as financial derivatives linked to bets on the Fed's policy outlook priced in a large probability that the Fed would pull the trigger at its June 13-14 meeting.

The idea runs against the Fed's projections in March about two additional hikes following the March move. Yet some investors say the Fed may be forced to pause given the uncertainty surrounding the outlook for the U.S. growth momentum, inflation and fiscal stimulus.

"Although the committee may want to raise rates again, we feel the Fed will tighten in June and then shift its focus to the reduction of its balance sheet," said Sean Simko, head of fixed-income portfolio management at SEI Investments.

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

(END) Dow Jones Newswires

May 25, 2017 12:42 ET (16:42 GMT)