BOND REPORT: Long-dated Treasury Yields Tumble To November Lows After Fed Moves

By Sunny Oh Features Dow Jones Newswires

Core consumer-price inflation hits lowest in 2 years

Continue Reading Below

Long-dated Treasury yields plummeted--and prices surged--to their lowest level since November after tepid inflation numbers outweighed the Fed's announcement that it would raise rates a quarter-point and look to reduce its balance sheet this year.

The yield for the 2-year note , the Treasury note most sensitive to changes in Fed policy, fell 2 basis points to 1.343%, paring a more severe 8 basis-point tumble. Bond prices move inversely to yields; one basis point is one hundredth of a percentage point.

The yield for the benchmark 10-year note slumped 6.8 basis points to 2.138%, the biggest one-day decline in about a month and its lowest level since Nov. 10, while the 30-year bond, or the long bond, fell 7.7 basis points to 2.783%, the lowest since Nov. 8.

Earlier, Treasury yields across the board plummeted after the release of tepid inflation data. Consumer-price inflation, or cost of living, slowed to 1.9% in May from 2.2% in April (http://www.marketwatch.com/story/inflation-falls-again-in-may-as-cpi-recedes-from-recent-high-water-mark-2017-06-14), while the core index, which strips out volatile energy and food prices, rose 0.1% in May. Compared with a year ago, core CPI was up 1.7%, the lowest in 2 years. Retail sales fell 0.3% in May (http://www.marketwatch.com/story/us-retail-sales-in-may-are-weakest-in-16-months-2017-06-14), the weakest in 16 months.

Lower inflation is bullish for bonds, because a rise in inflation can erode the value of bond's fixed interest payments.

Continue Reading Below

Short-dated yields partially cut their earlier drop after the Fed's policy statements showed senior Fed officials were still intent on hiking interest rates at least one more time and reducing the balance sheet in 2017. Monetary tightening can encourage selling in existing bonds, pushing yields higher, as investors anticipate richer rates from newly issued paper.

However, the central bank cut their inflation expectations, conceding weak economic data could change their outlook for the pace of rate increases.

The five-year, five-year forwards rates (https://fred.stlouisfed.org/series/T5YIFR), one of the ways the Fed gauges inflation expectations, had most recently fallen to 1.83%, suggesting investors agree with the central bank's updated inflation assessment.

"The market is taking this as a little more hawkish statement. It looks like as it stands, policy normalization is still on track, but [the Fed] are watching inflation developments," said Jennifer Lee, senior economist at BMO Capital Markets.

Long-dated yields failed to rebound from their seven-month lows after investors said the Fed's current tightening path would slow the U.S. economic expansion.

See: Fed raises interest rates and sets plan to shrink $4.5 trillion balance sheet 'this year' (http://www.marketwatch.com/story/fed-raises-rates-and-sets-plan-to-shrink-balance-sheet-this-year-2017-06-14)

The yield curve, sometimes interpreted as the bond market's forecasts for inflation, flattened after the policy statement's release. The spread between the 2-year note and the 10-year note (https://fred.stlouisfed.org/series/T10Y2Y), one way to chart the curve, narrowed to 80 basis points on Wednesday, close to a spread of 75 basis points from July 2016, representing the flattest level since 2007.

"The bond market is saying if the Fed was to follow through with their forward path of rate hikes, it would be too aggressive, and it would hurt further inflation from growing," said Matt Toms, chief investment officer for fixed income at Voya Investment Management.

But others felt given the minor reaction in long-dated yields after the policy statement's release showed investors doubted the Fed's ability to carry out their planned balanced-sheet reduction. A trimming of the Fed's $4.5 trillion portfolio of securities can raise Treasury yields as it would take away a significant buyer from the market.

"The continued flattening of the curve, and why the long end is holding up is the market's assessment that they're unsure how the Fed is going to get that done," said Sharon Stark, fixed-income strategist for Incapital, an investment management firm.

Read: Here's what the market thinks the Fed has got wrong (http://www.marketwatch.com/story/heres-what-the-market-thinks-the-fed-has-got-wrong-2017-06-13)

(END) Dow Jones Newswires

June 14, 2017 17:04 ET (21:04 GMT)