BOND REPORT: Short-dated Treasury Yields Rise After Inflation Boost Lifts Rate Increase Prospects

By Mark DeCambre, MarketWatch , Sunny Oh Features Dow Jones Newswires

10-year U.K. gilt yields jump after BOE highlights need for tighter monetary policy

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Short-dated Treasury yields rose on Thursday after a key read of consumer inflation increased more than expected, leading investors to wager that another rate increase before the end of 2017 was back on the table.

The yield on the 2-year Treasury note, sensitive to shifts in expectations for Fed policy, rose 2.5 basis points to 1.380%, compared with 1.355% on Wednesday when it hit its highest level since Aug. 8 (http://www.marketwatch.com/story/treasurys-tread-water-ahead-of-inflation-report-2017-09-13). Traders on the fed-fund futures market were pricing in a 50% chance for a rate increase for the first time since early July.

Bond prices and yields move inversely.

However longer-dated Treasury prices rebounded, threatening to snap a multiday rise in yields, after investors parsing through the report found it contained more disappointing details than the initial number suggests. The 10-year Treasury note yield was at 2.196%, versus 2.207% in the prior session, while the 30-year Treasury bond was at 2.785%, compared with 2.794% Wednesday.

Treasury yields across the board spiked after the consumer-price index rose 0.4% in August, with economists polled by MarketWatch forecasting 0.3% rise for the inflation gauge. This pushed up the year-over-year inflation rate higher to 1.9%, close to the Fed's long-term 2% target. But core inflation data, which strips out volatile gas and food prices, stabilized at 1.7% year-over-year, having stayed at that level since May.

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See: Gas and rent boost inflation, but Medicare care rises at slowest pace since 1965, CPI shows (http://www.marketwatch.com/story/higher-rents-gas-boost-inflation-in-august-cpi-shows-2017-09-14)

After five straight months of sluggish consumer prices, bond investors took heart at the rebound in economic data. Fed Chairwoman Janet Yellen had insisted the deterioration in the inflation trend over the spring and summer months was "transitory," her justification for raising rates in June and continuing headlong with the central bank's plans to normalize monetary policy.

"This is the first evidence that the unexpected slump earlier this year is just transitory," said Paul Ashworth, chief U.S. economist for Capital Economics, in a note to clients.

But long-dated Treasury yields retreated later after investors found pockets of concern within the report. Analysts point out growth in health-care prices slowed the most since 1965. And hourly wages adjusted for inflation fell 0.3%, bringing this year's gains to a mere 0.6% despite tight labor markets.

Initial jobless claims in the 7-day period ending Sept. 10 fell to 284,000 from 298,000, a sign that those afflicted by Harvey are returning to work. (http://www.marketwatch.com/story/us-weekly-jobless-claims-drop-ahead-of-irma-2017-09-14)

Central bankers are betting that higher wages will eventually translate in to the necessary inflation needed to lift interest rates further in 2017. The Fed meeting is set for Tuesday and Wednesday next week.

The reading comes a day after the Labor Department's producer-price index for August came in weaker than expected, rising 0.2%. Because inflation can chip away at a bond's fixed value over time, signs of weak inflation have tended to support lower yields and higher prices.

The recent period of yields climbing off recent lows, however, has been supported by a slightly lowered perception of global risk factors, including concerns centered on North Korea's military antagonism in the Korean Peninsula and a spate of damaging hurricanes in the U.S., market participants say.

Elsewhere, the Bank of England on Thursday kept its key interest rate on hold and made no changes to its quantitative-easing program, but warned that rates could rise faster than traders currently are pricing in (http://www.marketwatch.com/story/boe-says-it-may-hike-interest-rates-within-months-2017-09-14).

The yield of the British 10-year government bond, known as gilts , jumped to 1.202%, compared with 1.139% before the BOE announcement, as did the pound against the dollar at climbing to around $1.335.

(END) Dow Jones Newswires

September 14, 2017 10:43 ET (14:43 GMT)