BOND REPORT: Short-term Treasury Yield Hits Highest Since 2009, As Bonds Sell Off A Fourth Session

By Sunny Oh and Saumya Vaishampayan Features Dow Jones Newswires

More central banks may be following the Federal Reserve's hawkish lead, sending bond yields skyrocketing for the week

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U.S. government bond prices on Friday got hit, extending yield gains to a fourth straight session, as investors close out a bruising week for government paper, marked by renewed hand-wringing about the policy posture of global central banks. A flattening yield curve, implying concerns about sluggish inflation and the staying power of an improving global economic outlook have colored trading sentiment in Treasurys during the month, quarter and first half of the year, which has come to a close.

On Friday, the 2-year Treasury yield ,-- the most sensitive to policy expectations from the Federal Reserve--rose 1.2 basis point to 1.385%, contributing to a gain over the first six months of the year of 19.3 basis points. Yields are now at the highest since June 2009.

Bond prices move up as yields go down; one basis point is one hundredth of a percentage point.

The 10-year Treasury yield added 2.8 basis points to 2.298% for the day, helping to pare declines in the first half of the year, but still resulting in a 15 basis-point drop so far in 2017. While, the 30-year bond rang up the biggest yield drop, slumping 23 basis points over the same period.

Short-dated yields have steadily risen in step with the Fed's two rate increases this year, but long-dated yields have slid lower as bond bulls stay pessimistic over the growth and inflation outlook in 2017. As a result, the yield curve, which charts yields against the maturity of the bond, has flattened to levels worrisome to economists fearing a recession. Flat and inverting yield curves have traditionally been good predictors of slowing economic growth.

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A decoupling of short-ended bonds and long-ended bonds has stemmed from a showdown between a Fed, intent on tighter policy, and investors who see no sign of higher rates amid anemic inflation. So far, the last three months of consumer-price reports have highlighted lower-than-expected inflation.

"The recent drop in inflation may alter the timing of rate increases and may put more emphasis on Fed balance-sheet reduction than fed-funds rate increases. That shift will cause the yield curve to steepen short term," said John Bredemus, investment strategist for Allianz Investment management.

Bond bulls taking heart at the low levels of the benchmark 10-year note, however, appeared complacent after Treasurys were hit in the recent week by the prospect of global monetary tightening. Foreign investors have had little choice but to turn to U.S. bonds and away from Europe and Japan, where interest rates, and therefore returns have hovered near zero. But the potential for higher rates in Europe could cause money flows to reverse the other way.

The impact of the changing rates structure between the U.S. and overseas was highlighted when global bond markets were thrown into a panic by a series of central banker statements, which were interpreted as signaling that easy-money days may be coming to a close. Yields for European government paper soared midweek after European Central Bank President Mario Draghi, Bank of England Gov. Mark Carney and Bank of Canada Gov. Stephen Poloz hinted that the Western economies had strengthened, leading some to believe that they were preparing the market for the removal of monetary-easing measures.

The German 10-year government bond, or the bund, surged more than 20 basis points this week in what some dubbed a mini taper-tantrum, a nod to the selloff in bond markets during 2013, when then-Fed chief Ben Bernanke said the central bank may end its bond purchases.

Central banks like the ECB, Bank of Japan and Federal Reserve have bought massive amounts of bonds, as they tried to shore up their economies in the wake of the financial crisis. The Fed stopped buying bonds in 2014 and has since started raising short-term rates. The recent remarks from Draghi (http://www.marketwatch.com/story/what-happened-to-mario-draghis-silver-tongue-2017-06-28) and others suggest more central banks might be following suit, leaving investors increasingly on the lookout for clues about the timing of such a shift.

Read:Central banks set up investors for a long, hard road back to 'normal' (http://www.marketwatch.com/story/investors-face-a-long-hard-road-back-to-normal-2017-06-29)

And see:Here's why the stock market is spooked by central bankers (http://www.marketwatch.com/story/heres-why-the-stock-market-is-spooked-by-central-bankers-trump-agenda-delays-2017-06-29)

(END) Dow Jones Newswires

June 30, 2017 18:41 ET (22:41 GMT)