Treasurys Rally Following Soft Inflation Data

U.S. government bonds strengthened Friday following the release of softer-than-expected inflation data.

Excluding the often-volatile categories of food and energy, the consumer-price index rose just 0.1% in April from the previous month, below the 0.2% gain anticipated by economists surveyed by The Wall Street Journal.

While overall consumer costs rose 2.2% from a year earlier, the gain was 1.9% excluding food and energy, marking the first time the annual increase in core prices was below 2% since October 2015.

In recent trading, the yield on the benchmark 10-year Treasury note was 2.356%, according to Tradeweb, compared with 2.400% Thursday and 2.352% one week ago. Yields fall when bond price rise.

Inflation is a main threat to bonds, eroding their fixed returns over time.

Also released Friday was data on retail sales, which increased a seasonally adjusted 0.4% in April from the prior month. That was below the 0.5% gain economists had expected. But it still was the largest increase in three months and came with positive revisions to earlier data.

Both inflation and consumer spending data improved from March, "but I think the market was looking for a bigger rebound," said Priya Misra, head of global rates strategy at TD Securities in New York.

Fed-funds futures, used by investors to bet on the Federal Reserve interest-rate policy outlook, showed Friday 74% odds that the Fed would tighten monetary policy by its June 13-14 meeting, according to CME Group. The odds were 83% Thursday.

The yield on the 10-year Treasury note has climbed in recent weeks after falling to five-month low of 2.177% on April.

The rise has reflected a retreat in perceived political risks, with the conclusion of the France's presidential election, as well as increasing expectations that the Fed will raise interest rates next month.

New supply of government and corporate debt also weighed on bond prices this week. But prices had already started to climb overnight as that pressure dissipated, analysts said.

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

U.S. government bonds strengthened Friday, dropping the yield on the 10-year note back toward 2.3% as a new report showed softer-than-expected inflation.

Excluding the often volatile categories of food and energy, the consumer-price index rose 0.1% in April from the previous month, the Labor Department said. That was below the 0.2% gain anticipated by economists surveyed by The Wall Street Journal.

While overall consumer prices rose 2.2% from a year earlier, the increase amounted to 1.9% excluding food and energy, marking the first time the annual gain in core prices had been below 2% since October 2015.

Demand for bonds pushed the yield on the benchmark 10-year Treasury note down to 2.331%, compared with 2.400% Thursday and 2.352% a week ago. Yields fall when bond prices rise.

Debt investors keep a close eye on inflation because it is a main threat to bonds, eroding their fixed returns over time. Higher inflation also makes it more likely that the Federal Reserve will raise interest rates, which reduces money supply in the economy and tends to diminish the value of outstanding government debt.

The small uptick in consumer prices last month followed an unexpected decline in March, which many investors had viewed as a one-time event.

Fed officials have expressed confidence that inflation will stabilize around their 2% target. The Fed's preferred measure of inflation is the Commerce Department's personal-consumption expenditures price index, which advanced 1.8% from a year earlier in March and tends to run below the consumer-price index.

Some economists believe it is only a matter of time before inflation settles at or surpasses the Fed's target, as the labor market tightens and employers are forced to pay workers more. Last month, the unemployment rate fell to its lowest level in a decade. Still, wage growth has been slow, and many bond investors have maintained a wait-and-see attitude toward inflation, preventing yields from rising higher.

The general view in the market is that "we are showing sub-2% inflation" and that means there is "probably going to be less Fed activity," said Sean Simko, head of fixed-income portfolio management at SEI.

Even after the inflation report, many investors remain confident that the Fed will raise rates at its June 13-14 meeting, given strong signals from officials that they are ready to act again after last raising rates in March.

Fed-funds futures, used by investors to bet on the Federal Reserve interest-rate policy outlook, showed on Friday a 74% chance that the Fed would tighten monetary policy at its next meeting, according to CME Group.

Still, investors are cautious about predicting more rate increases, with an additional move by the Fed this year assigned just a 50% chance.

Current bond yields reflect the ambivalence of investors. While the yield on the 10-year Treasury note has recovered from the five-month low of 2.177% it reached last month, it remains well below the 2.6% level it briefly touched in March.

In recent weeks, investors have become less concerned about political risks overseas.

Many, though, are less optimistic than they once were about fiscal stimulus in the U.S. That has made it easier for them to buy Treasurys, given the diminished odds of faster economic growth, higher inflation and increased bond issuance that could accompany such policies.

Some analysts said the sharp drop in bond yields Friday wasn't entirely justified by the economic data. Though it fell short of expectations, the consumer-price index still improved from the previous month. Retail sales also rose 0.4% in April, below the 0.5% gain economists had expected but the largest increase in three months.

In both cases, there was "a rebound, but I think the market was looking for a bigger rebound," said Priya Misra, head of global rates strategy at TD Securities in New York.

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

(END) Dow Jones Newswires

May 12, 2017 16:12 ET (20:12 GMT)