U.S. Government Bonds Soften

By Min Zeng Features Dow Jones Newswires

The U.S. government bond market started June's trading on a down note as a report showed the U.S. private-sector jobs growth accelerated last month, sapping demand for haven assets.

Continue Reading Below

The report bolstered the case for the Federal Reserve to raise short-term interest rates later this month. But the subdued selling pressure in the bond market reflects investors' hesitance to place large bets ahead of Friday's nonfarm payrolls release. The NFP is a more comprehensive metric of the labor market and a key monthly data point to influence the Fed's interest rate policy decisions.

In addition, some investors and analysts are starting to question whether signs of slowing inflation could potentially push the Fed to stand pat during the second half of the year, a case that would reduce the risk of a big rise in yields and attract buying interest in long-term Treasurys.

"The question is what would happen beyond June," said Brian Daingerfield, macro strategist at NatWest Markets. "The labor market seems to continue to be on solid footing, but inflation readings have softened and some Fed officials are taking note."

The yield on the benchmark 10-year Treasury note settled at 2.217%, compared with 2.198% Wednesday. Yields rise as bond prices fall.

The bond market has been baffling investors this year as it has been strengthening along with a record-setting rally in the stock market. That is a shift from late last year when sell Treasurys and buy stocks was in vogue for investors to bet on large fiscal stimulus in the U.S. that would lead to stronger economic growth and higher inflation.

Continue Reading Below

Yet so far this year the 10-year yield has dropped by more than 0.2 percentage point and traded near the lowest level in 2017 even as the Dow Jones Industrial Average has soared by more than 1,300 points. Some investors say the bond market is flagging skepticism toward the narrative of higher growth and inflation especially as confidence is waning over President Donald Trump's fiscal agenda this year.

This month's slowdown in inflation, with some metrics drifting below the Fed's 2% target again, added to signs of caution in chasing riskier markets and potentially complicating the Fed's plan in tightening monetary policy.

The 10-year Treasury yield had jumped to 2.238% earlier Thursday after a report showed the U.S. private sector added 253,000 jobs last month, according to payroll processor Automatic Data Processing Inc. and forecasting firm Moody's Analytics, much stronger than 180,000 expected by economists polled by The Wall Street Journal.

Economists expect Friday's NFP to show that the world's biggest economy added 184,000 nonfarm jobs last month, following a net gain of 211,000 in April. The unemployment rate is forecast to hold steady at 4.4%, a level seen by many economists as a sign the labor market is approaching full employment.

"June is probably done as long as payrolls are not surprisingly weak," said Gemma Wright-Casparius, senior money manager at Vanguard Group But if lower inflation persists, "then I suspect [Fed officials] will pause and pursue the balance sheet reduction earlier."

Analysts say the wage inflation indicator from Friday's employment report will be highly scrutinized. The pace of wage growth has been slower than many investors expect despite signals that the labor market is approaching full employment -- a scenario that has been nagging both Fed officials and investors.

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.

Praveen Korapaty, head of interest rate strategy at Credit Suisse, said it is premature to declare that the tide is shifting toward lower inflation. Fed officials are likely to wait for more inflation data in coming months before altering its trajectory of rate increases, said Mr. Korapaty.

He still expects the Fed to raise interest rates one more time later this year following a rate increase in June, and that the 10-year yield is likely to rise to 2.8% at the end of the year.

Fed officials are split on the inflation outlook.

Tuesday, Fed Governor Lael Brainard said if price pressures don't begin to rise again toward the Fed's official 2% increase target rate then rises later in the year might not have her support. Yet Fed Governor Jerome Powell on Thursday sounded a sanguine note on the outlook for prices, saying some of the recent weakness can be explained by transitory factors.

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

(END) Dow Jones Newswires

June 01, 2017 15:50 ET (19:50 GMT)