U.S. Government Bonds Extend Declines

By Sam Goldfarb Features Dow Jones Newswires

U.S. government bonds pulled back sharply Tuesday as Congress neared final passage of a major tax overhaul.

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After long playing down the potential impact of a tax overhaul, bond investors have appeared to reverse course this week, causing them to sell bonds to guard against the risk of growing debt supply, stronger inflation and a more aggressive path of interest-rate increases from the Federal Reserve.

The yield on the benchmark 10-year Treasury note settled Tuesday at 2.464%, its highest close since March 20, compared with 2.392% Monday and 2.353% just two sessions ago. Yields rise when bond prices fall.

After months of negotiations, the House of Representatives passed what was thought to be a final version of a tax overhaul bill on Tuesday afternoon. Later, House GOP leaders scheduled a revote after the Senate parliamentarian ruled that three provisions in the bill violated fast-track procedures. But the Senate was still expected to vote Tuesday, and the House could clear the legislation for President Trump's signature by Wednesday.

The tax overhaul poses several risks to investors. The legislation, which is expected to lower federal revenues by $1.5 trillion over 10 years, could weigh on the prices of existing bonds by increasing the supply of new debt. The bill could also lift economic growth and inflation, eroding the fixed returns of government bonds and making it easier for the Fed to tighten monetary policy.

Still, many bond investors have been skeptical that tax cuts could do much to stoke inflation, which has remained stubbornly soft this year. There has also been uncertainty about how the Treasury Department will fund its additional borrowing needs, with some signs that it could spare long-term bonds by focusing mostly on short-term debt issuance.

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Through last week, the 10-year yield had been holding steady below 2.4% and its premium to the two-year Treasury yield, a gauge of the so-called yield curve, had been shrinking, a sign that investors were largely indifferent to tax cuts.

"I don't know what happened, but all of a sudden the market woke up to the tax bill," said Ray Remy, head of fixed-income trading in New York at Daiwa Capital Markets America Inc.

Apart from progress on taxes, analysts also attributed Tuesday's selloff to an announcement by the German Finance Agency that it plans to increase issuance of 30-year bonds next year, a move that had its largest impact on German bonds but that also spilled into the U.S. market.

U.S. housing starts also unexpectedly rose 3.3% in November, adding to a run of encouraging economic data.

Write to Sam Goldfarb at sam.goldfarb@wsj.com

(END) Dow Jones Newswires

December 19, 2017 17:26 ET (22:26 GMT)