BOND REPORT: Government Bonds Draw Bids As U.S.-North Korea Tensions Mount

St. Louis Fed President said central bank could be too aggressive with raising rates in the face of anemic inflation readings

U.S. Treasurys on Wednesday drew buyers attracted to the perceived safety of government paper, pushing yields lower, as the world monitored escalating, bellicose rhetoric between the U.S. and North Korea.

The 10-year benchmark Treasury note's yield fell about 3.6 basis points to 2.246%, extending a yield slump seen over the first two days of the week. The yield for the two-year Treasury note was down 2.4 basis points, at 1.339%, while the 30-year Treasury fell 4.1 basis points to 2.825%. Yields fall as prices gain.

In Europe, the German 10-year government bond's yield shed nearly 5 basis points to 0.426%.

A shift to haven assets also saw investors buy Swiss francs, the Japanese yen--which hit an eight-week high against the dollar (http://www.marketwatch.com/story/dollar-slides-vs-swiss-franc-as-us-north-korea-discord-prompts-run-to-safety-2017-08-09)--and gold futures, (http://www.marketwatch.com/story/gold-gains-about-1-as-us-north-korea-tensions-grow-2017-08-09) which all tend to lure bidders in times of uncertainty or fear, and move inversely to risk assets like stocks. The Dow Jones Industrial and the S&P 500 index declined along with other global equity benchmarks.

Swings on Wall Street come as North Korean leader Kim Jong Un made his most explicit threat to strike a U.S. military base in Guam (http://www.marketwatch.com/story/north-korea-threatens-missile-strike-on-us-base-on-guam-2017-08-08) following President Donald Trump's warning to Pyongyang not to "make any more threats" to the U.S., saying it would face a "fire and fury" response (http://www.marketwatch.com/story/trump-today-president-says-north-korea-faces-fire-and-fury-if-it-doesnt-halt-threats-2017-08-08) "like the world has never seen."

Still, despite a dip in yields, implying demand for sovereign paper has picked up, one measure of volatility in government bonds was relatively muted, according to Tom di Galoma, managing director of Treasury trading at Seaport Global.

Bank of America Merrill Lynch's MOVE index was currently around 47.34, below its one year average of about 64.5 and five-year average of 69.59. The Treasury trader attributed the muted reaction in the bond-volatility gauge to market participants continuing to sell volatility and few buyers emerging, as the hopes of a spike in yields diminishing.

That said, di Galoma said he viewed a "North Korea skirmish or battle, a very realistic thing."

Trump's comments on Tuesday came after the Washington Post report (https://www.washingtonpost.com/world/national-security/north-korea-now-making-missile-ready-nuclear-weapons-us-analysts-say/2017/08/08/e14b882a-7b6b-11e7-9d08-b79f191668ed_story.html?utm_term=.0938becb046e) that North Korea has built a miniaturized nuclear warhead, that could give it the ability to deliver a nuclear-grade payload to a target in the Asian region.

"The bellicose rhetoric from the U.S. and North Korean officials is the main driver today. We would qualify that assessment by noting that first, the market moves are rather modest, suggesting a low-level anxiety among investors. Second, that the pre-existing trends have mostly been extended," said analysts at Brown Brothers Harriman, in a note.

But yields for government paper gave back some of their decline by midday in New York, as investors braced for an auction of 10-year Treasurys which ended up attracting tepid demand. However that poor sale contrasted with a separate 3-year auction on the prior day that lured more demand.

Some strategists theorized that the contrasting auctions reflect fading expectations of many more near-term rate hikes as the Fed attempts to tighten monetary policy. Shorter-term Treasurys tend to be the most sensitive to rate increases.

This view appeared to gain influential backers as two Fed speakers said the central bank should be cautious when tightening monetary conditions. St. Louis Fed President James Bullard, a nonvoting member, said he was surprised by the softness in inflation readings and saw the risk that the central bank could be excessively aggressive on rate hikes (http://www.marketwatch.com/story/fed-risks-being-too-aggressive-on-rate-hikes-bullard-says-2017-08-09).

At a breakfast interview with reporters, Chicago Fed President Charles Evans, a voting member, felt it was "reasonable" to expect balance sheet reduction to start in September but pushed back discussion of a rate hike to December, saying he would need "many more months of inflation data" before he was comfortable with supporting an increase.

See: Here's what the Fed's Evans thinks about the economy and interest rates (http://www.marketwatch.com/story/feds-evans-backs-balance-sheet-reduction-but-ambivalent-toward-another-rate-hike-2017-08-09)

(END) Dow Jones Newswires

August 09, 2017 16:23 ET (20:23 GMT)