BOND REPORT: Treasury Yields Climb From 2017 Lows Following U.S. Data

Gilt yields climb after Bank of England leaves rates unchanged

U.S. Treasury yields rose on Thursday, with the 10-year benchmark note coming off its lowest level in 2017, after the Federal Reserve delivered its fourth interest-rate hike in about 18 months and outlined plans to unwind its $4.5 trillion balance sheet.

The overall hawkish tone of the central bank's updated policy statement and a question-and-answer session on Wednesday following its decision was read by some as underscoring the Fed's desire to normalize monetary policy, despite sluggish inflation.

The 10-year Treasury note ticked up 3 basis points to 2.162%, compared with 2.138% late Wednesday in New York, which marked the lowest yield for the benchmark note since Nov. 10 (http://www.marketwatch.com/story/us-10-year-treasury-yield-drops-to-lowest-since-november-ahead-of-fed-policy-update-2017-06-14). The 2-year Treasury note--the most sensitive to interest-rate moves--rose 2 basis points to 1.363%, compared with 1.343% in the previous session, while the 30-year Treasury , known as the long bond, edged up 0.4 basis point at 2.787%, compared with 2.783% late Wednesday.

Bond prices and yields move inversely and one basis point is equal to one hundredth of a percentage point.

Guy LeBas, chief fixed-income strategist at Janney Montgomery Scott, said over the past 12 to 18 months Treasury yields have been positively correlated with the value of the U.S. dollar. That is, the dollar and yields have risen together.

"Japanese institutional investors are the marginal buyer of Treasurys and they have been buying when yen strengthened. So, when the dollar rises, Treasury prices would fall and yields rise, as is happening on Thursday," LeBas said.

On Thursday, the ICE U.S. Dollar index rose 0.5% to 97.418, while the dollar bought Yen110.77, up 1% from Yen109.56 late Wednesday in New York.

In economic news, the price of imported goods fell in May (http://www.marketwatch.com/story/prices-of-imported-goods-post-steepest-drop-in-15-months-2017-06-15)by the largest amount in 15 months in another sign U.S. inflation has cooled after a sharp runup last year. Meanwhile, the labor market continues to remain strong with weekly initial jobless claims (http://www.marketwatch.com/story/us-jobless-claims-fall-8000-to-237000-2017-06-15) dropped by 8,000 to 237,000. Manufacturing data from Philadelphia Fed and Empire State (http://www.marketwatch.com/story/philly-empire-manufacturing-gauges-show-strength-in-june-2017-06-15) index came in better than expected, showing some strength, although a measure of industrial production (http://www.marketwatch.com/story/industrial-output-flat-in-may-after-strong-gain-in-prior-month-2017-06-15) was flat in May after jumping by the largest amount in more than seven years in the prior month.

On Wednesday, ahead of the Fed's policy update, yields jolted lower as key measures of inflation suggested that the central bank may be inclined to temper its pace of rate hikes. A U.S. government report showed that the consumer-price index in May was up 1.9% (http://www.marketwatch.com/story/inflation-falls-again-in-may-as-cpi-recedes-from-recent-high-water-mark-2017-06-14) on an annualized base, dipping below the Fed's 2% target again. Excluding food and energy, CPI rose 1.7% over the past 12 months through May, representing the smallest gain since May 2015.

Anticipating lower inflation in future, investors tend to buy longer-dated bonds in hopes of locking in at higher rates. A flight to quality after the CPI data on Wednesday morning pushed yields sharply lower.

However, Yellen & Co. offered a relatively sanguine outlook for inflation and the U.S. economy at her Wednesday afternoon news conference, cautioning Wall Street "not to overreact to a few readings," even as the Federal Open Market Committee lowered its inflation outlook (http://www.marketwatch.com/story/fed-raises-rates-and-sets-plan-to-shrink-balance-sheet-this-year-2017-06-14).

"This combination of a hawkish take on the recent inflation news and a continued emphasis on forestalling excessive labor market overheating left the dots fairly stable," wrote Goldman Sachs strategists Jan Hatzius, Alec Phillips and David Mericle in a Wednesday research note, after the Fed's decision, which included a quarter-point rate increase to a range between 1% and 1.25%, as widely expected.

Goldman's analysts said the U.S. central bank reinforced the notion of at least one more rate increase in 2017, but the investment bank says the probability of a rate increase in September is only 10%, forecasting that the next rate increase will likely be in December, given the Fed's balance-sheet reduction plan. Shrinking the Fed's balance sheet can serve as an added tightening tool.

The Fed said it would shrink its balance, setting a selling cap of $10 billion a month and then raising it to $50 billion a month. If implemented, this means up to $300 billion in balance sheet reduction in the first 12 months and up to $600 billion a year thereafter.

One area of concern for is a narrowing risk premium between 2-year and 10-year notes, which fell to 80 bass points on Wednesday, marking the narrowest level between those short-term and long-term instruments since July. A shrinking premium, or flattening yield curve, is read by some market participants as signaling a dimming outlook for inflation and the economy.

In Europe, the yield on 10-year U.K. bonds jumped by 7 basis points to 1.01% after Bank of England left key interest rate unchanged (http://www.marketwatch.com/story/bank-of-england-holds-key-rate-at-025-with-3-policy-makers-voting-for-a-hike-2017-06-15), as expected, but two members wanted to hike rates, greater dissention than anticipated. The German 10-year benchmark bond , known as the bund, meanwhile, was at 0.29%.

(END) Dow Jones Newswires

June 15, 2017 11:04 ET (15:04 GMT)