U.S. Government Bonds Strengthen

By Min Zeng Features Dow Jones Newswires

U.S. government bonds strengthened broadly after the long holiday weekend as the latest inflation report bolstered some investors' expectations that the Federal Reserve would be slow in raising interest rates.

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The yield on the benchmark 10-year Treasury note settled at 2.217%, down from 2.248% Friday. Yields fall as bond prices rise. The yield approached the 2.177% set on April 18, which was the lowest close since November.

The yield premium investors demanded to hold the 10-year note relative to the two-year Treasury debt was 0.93 percentage point Tuesday, the lowest level since October. The premium has fallen after rising above 1.3 percentage point in December.

A shrinking premium is known as a flattening yield curve, a sign investors are worried that the growth momentum is waning, leading to decelerated inflation. A flattening yield curve tends to reduce the profit margins for banks, which typically borrow short-term cash and then lend out money for the long term to consumers and businesses.

Tuesday's report showed the Fed's favorite gauge of inflation rebounded in April but, on an annual basis, the indicator drifted below the central bank's 2% target. The personal-consumption expenditures price index was 1.7% on an annualized base in April, down from 1.9% in March. Excluding food and energy, the reading was 1.5%, down from 1.6% in March.

"The Fed has already strongly signaled that it will act in June and I believe a June hike is baked in," said Larry Milstein, head of government and agency trading at R.W. Pressprich & Co. If inflation continues to recede, "we will not see another move by the Fed in 2017" after a June move, he said.

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This month's releases indicate that after a recent uptick, inflation is slowing down. The consumer-price index report excluding food and energy, released earlier this month, fell below 2% for the first time since October 2015.

Fed governor Lael Brainard said Tuesday that the failure to get inflation back to the 2% target is "a source of concern."

Easing inflation risk makes long-term Treasury debt more appealing to buyers because inflation is considered as a main threat. Higher inflation chips away bonds' fixed returns over time and reduces investors' purchasing power from their bond investments.

"We are not seeing strong numbers in inflation," said Andrew Pace, vice president at Performance Trust Capital Partners LLC. "The bond market is showing that without a pickup in inflation, many investors are not worried about a big rise in yields."

The 10-year Treasury yield has fallen from 2.282% at the end of April, setting up the note's price for a monthly gain. Traders say month-end buying is likely to provide some support for the bond market Wednesday.

During the last trading session of a month, newly minted bonds replace maturing debt in some bond indexes. Fund and portfolio managers who track bond indexes need to replicate the move by buying Treasurys. Some investors adjust their portfolios before the last trading session of a month.

After a big rise in late 2016, the 10-year Treasury yield has been falling this year. The sell-Treasury trade was in vogue after the U.S. presidential elections in November for investors to bet on stronger growth and higher inflation. But skepticism toward President Donald Trump's fiscal agenda has driven investors to unwind or cut positions betting on higher bond yields.

Lower bond yields this month also reflect thinking in the bond market that after a possible increase in June, the Fed may stand pat for the rest of the year, say some analysts.

The idea runs against the Fed's projections in March about two additional increases 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.

This week's key data point is the nonfarm jobs report due Friday. Investors not only look at the jobs growth number, but also scrutinize the gauge of wage inflation. The pace of wage growth has been slower than many investors expect despite signals that the labor market is approaching full employment, a puzzle that has been nagging both Fed officials and investors.

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

(END) Dow Jones Newswires

May 31, 2017 10:59 ET (14:59 GMT)