BOND REPORT: U.S. 10-year Treasury Yield Drops To Lowest Since November Ahead Of Fed Policy Update

By Sunny Oh Features Dow Jones Newswires

Core consumer price inflation lowest in 2 years

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Treasury yields tumbled--and prices surged--to their lowest level since November after weak inflation numbers diminished expectations for the Federal Reserve to lift interest rates at a rapid pace for the rest of the year, ahead of a key rate decision Wednesday afternoon.

The yield for the benchmark 10-year note slumped 10.7 basis points to 2.105%, the biggest one-day decline in about a year. Bond prices move inversely to yields; one basis point is one hundredth of a percentage point.

The yield for the 2-year note , the Treasury note most sensitive to changes in Fed policy, fell 7.7 basis points to 1.290%. The drop is the biggest one-day decline since June 3, 2016.

The 30-year bond, or the long bond, fell 9.1 basis points to 2.775%.

Traders are betting that the central bank may need to adopt a more gradual pace of monetary tightening. 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.

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

"We don't think that it derails the Fed this afternoon (although perhaps it should), but it makes tightening later this year much more difficult," said Ian Lyngen, head of U.S. rates strategy at BMO Capital Markets, in a note. He downgraded the likelihood of a rate increase after September's policy meeting, the next earliest opportunity for a rate increase after June.

See: Even after weak data, Fed still seen hiking rates--but not in September (http://www.marketwatch.com/story/even-after-weak-data-fed-still-seen-hiking-rates-but-not-in-september-2017-06-14)

The Fed's updated policy statement is set to be released at 2 p.m. Eastern. With a Fed rate increase for Wednesday a near-certainty, investors would pay close attention to how the central bank is interpreting a batch of weaker-than-expected economic data. Fed Chairwoman Janet Yellen will hold a news conference shortly after the policy releases, which include a fresh take on Fed members' projections for future rate increases, known as the dot plot.

Market strategists said investors should look for a view on the debt ceiling and how the central bank intends to shrink its balance sheet. Senior Fed officials have said the central bank will cut its $4.5 trillion portfolio of securities only if its normalization of interest rates is fully under way. Balance sheet reductions can raise Treasury yields as it takes away a significant buyer from the market.

Despite the tepid inflation figures, some market participants felt the Fed couldn't be put off their plans for normalizing monetary policy in 2017, though they were still looking for further details on how the Fed intends to reduce its holdings of government paper and mortgage backed securities.

"Based on their statements, nothing I feel is going to deter their balance sheet reduction plan. What the market is waiting for is the timing and the amount," said Eric Souza, senior portfolio manager for SVB Asset Management.

Despite the central bank's insistence that the recent dip in inflation readings have been "transitory, (http://www.marketwatch.com/story/fed-holds-interest-rates-steady-dismisses-first-quarter-slump-as-transitory-2017-05-03)" the bond market has shown more pessimism over the near-term economic outlook. The spread between the 2-year note and the 10-year note fell to 83 basis points most recently from 133 basis points in Dec., is at the narrowest since last October, implying lowered expectations that inflation will hover around the Fed's target 2% level.

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 11:50 ET (15:50 GMT)