BOND REPORT: Yield Curve Flattens On Poor Economic Data And Rate-hike Expectations

By Sunny Oh Features Dow Jones Newswires

Long-dated Treasury yields fell while short-dated yields rose Tuesday after a raft of early economic data appeared to ding the outlook for fourth-quarter growth, but did little to scuttle the chances of an upcoming rate increase this December.

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What are Treasurys doing?

The benchmark 10-year note yield fell 2.3 basis points to 2.356%, while the 30-year bond yield declined 3.8 basis points to 2.732%.

But the two-year note yield rose 1.6 basis points to 1.826%. The combination of lower long-term rates and higher short-term rates helped to flatten the yield curve, a line tracing bonds' maturities and accompanying yields.

Yields and debt prices move in opposite directions.

What's driving markets?

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Investors saw a raft of tepid economic data that pared forecasts for fourth-quarter growth, pushing long-dated yields down. A wider trade deficit and a large drop in the nonmanufacturing index suggested recent growth momentum might be rockier than first thought. The weak economic data could not, however, dislodge expectations of a Dec. 13 interest-rate increase, the main driver of the upward climb in short-dated yields since early November.

But most market participants were still watching the progress of Republican tax legislation, a key issue for bond investors. The Republicans ran into roadblocks in their bid to reconcile the Senate and House versions of the tax bill after the Senate included a corporate alternative minimum tax, or AMT, in contrast to the House bill, which jettisoned the AMT for businesses.

If the final legislation raises deficits, the Treasury Department will have to ramp up issuance of government debt and possibly generate a supply glut, pushing bond prices lower.

See: Here's why the corporate AMT is a hurdle to a final tax bill (http://www.marketwatch.com/story/heres-why-the-corporate-amt-is-a-hurdle-to-a-final-tax-bill-2017-12-05)

What did market participants say?

"All cynicism aside, it's difficult to imagine that the corporate AMT problem isn't resolved quickly; after all including the provision would make the tax reform far less relevant. If the GOP's intention is to deliver the first major victory ahead of the midterm elections, this seems like more than just a procedural hiccup," said Ian Lyngen and Aaron Kohli, fixed-income strategists at BMO Capital Markets.

"The yield-curve flattening is based on a number of things. One of the [drivers] is we've got the Federal Reserve meeting next week, and they'll raise interest rates. You're probably looking at a minimum of three rate hikes in 2018, mainly because the Fed is trying to get in front of a possible recession, so they're trying to get rates higher," said Tom di Galoma, managing director of Treasurys trading at Seaport Global Securities.

What else is on investors' radar?

The trade deficit for October came in at $48.7 billion (http://www.marketwatch.com/story/us-imports-record-amount-of-goods-from-china-mexico-europe-as-trade-deficit-soars-2017-12-05), higher than the $47.6 billion forecast by economists polled by MarketWatch. The sharp increase in the deficit mostly emanated from rising prices for petroleum imports.

The Institute for Supply Management's nonmanufacturing index, a gauge of the service industry's health, fell to 57.4% in November (http://www.marketwatch.com/story/us-businesses-still-growing-rapidly-even-after-tapping-brakes-in-november-ism-finds-2017-12-05). Economists had expected a reading of 59.0%, down from 60.1% in October.

What other assets were on the move?

Bank of Japan Governor Haruhiko Kuroda said Tuesday he hadn't talked to Japanese Prime Minister Shinzo Abe about whether he would continue as the head of the central bank when his term ends next April, Reuters reported (https://in.reuters.com/article/us-japan-economy-kuroda/boj-kuroda-says-didnt-discuss-succession-plan-with-pm-abe-idINKBN1DZ0B0). Abe's election victory in October had led to mounting speculation that Kuroda would extend his tenure (http://www.marketwatch.com/story/heres-why-abes-japanese-election-victory-could-push-dollar-above-115-yen-by-year-end-2017-10-23).

The 10-year Japanese government bond yield edged higher to 0.40%, from 0.29% late Friday.

(END) Dow Jones Newswires

December 05, 2017 16:51 ET (21:51 GMT)