A deepening crude-oil rout sparked strong demand for long-term U.S. government bonds, sending the yield on the 30-year Treasury debt to the lowest level this year.
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U.S. crude-oil prices fell Tuesday to their lowest level since September and extended this year's losses to nearly 20%. Lower energy prices tend to deflate inflation expectations, making long-term Treasury debt more appealing. Inflation chips away investors' purchasing power from their bond investments and is seen by them as a big threat to the value of long-term Treasurys.
The 30-year Treasury debt was the best performer. The yield settled at 2.735% Tuesday, compared with 2.787% Monday. It marked the yield's lowest close since Nov. 8, 2016, when Donald Trump won the U.S. presidential race.
Yields fall as bond prices rise.
The yield on the benchmark 10-year Treasury note settled at 2.153%, compared with 2.188% Monday and near its 2017 close low of 2.138% set Wednesday.
The oil move further fires up the debate among investors on the inflation outlook. The U.S. consumer-price index in May fell below the Federal Reserve's 2% target again; commodities including energy have been weakening; and a gauge of long-term inflation expectations in the U.S. fell Tuesday to the lowest level since October.
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Yet after raising short-term interest rates for a second time this year, Federal Reserve Chairwoman Janet Yellen signaled Wednesday that slowing inflation reports over the past few months could be noisy. Ms. Yellen and some of her colleagues believe a robust labor market would eventually push up inflation, supporting the central bank's plan in normalizing interest-rate policy.
"The bond market doesn't believe that the Fed would carry through its plan in raising rates four times by the end of 2018," said Jim Leaviss, fund manager at M&G Investments.
The 10-year break-even rate, or the yield premium investors demanded to hold the 10-year Treasury note relative to the 10-year Treasury inflation protected security, was 1.66 percentage points Tuesday. That was the lowest level since October, a sign of diminished inflation expectations.
At this level, it suggests investors expect U.S. inflation to run at an annualized rate of 1.66% on average within the next 10 years. The break-even rate traded above 2% in January.
Falling inflation expectations may push consumers and businesses to delay spending, which would be negative for the economic growth.
Michael Collins, senior portfolio manager at PGIM Fixed Income, said the higher growth, higher inflation narrative following the U.S. presidential election has been reversing.
"Disinflation, not higher inflation, may be a bigger risk," a scenario that could send long-term Treasury yields down further still, he said.
Some investors are worried the Fed could make a policy error especially if they misjudge inflation.
The yield premium investors demanded to hold the 30-year bond relative to the five-year note on Tuesday was 0.977 percentage point. That marked the lowest level since 2007, according to Tradeweb.
A shrinking premium is known as a flattening yield curve, which is typically interpreted by investors as a sign that the U.S. economy may be losing momentum. Investors who subscribe to this view are selling shorter-term debt and migrating cash into longer-term bonds, adding to the flattening curve momentum.
New York Federal Reserve President William Dudley said Monday he is confident on the growth outlook, and the flattening yield curve isn't sending a negative signal for the economy. He believes it has been driven by global flows into the Treasury bond market because of its more attractive yields compared with many other developed government bond markets.
Some analysts side with this notion and caution investors should refrain from overinterpreting the bond market's signal.
Write to Min Zeng at email@example.com
(END) Dow Jones Newswires
June 20, 2017 16:19 ET (20:19 GMT)