U.S. Government Bonds Pull Back After Biggest Rally in Nearly a Year

The U.S. bond market pulled back Thursday after the biggest one-day price rally in nearly a year.

Demand for haven bonds eased as a bout of upbeat U.S. data deflated some worries over the growth outlook, offsetting political uncertainty surrounding the Trump administration and a brewing political crisis in Brazil.

The yield on the benchmark 10-year Treasury note was 2.228% in recent trade, according to Tradeweb, compared with 2.216% Wednesday. Yields rise as bond prices fall.

U.S. stocks rose after Wednesday's selloff, a sign risk appetites improved.

The 10-year Treasury yield had dropped to 2.181% earlier Thursday, near the lowest level this year.

Traders said the trigger was a report from Reuters saying that Michael Flynn and other advisers to President Donald Trump's campaign were in contact with Russian officials and others with Kremlin ties in at least 18 calls and emails during the last seven months of the 2016 presidential race.

Anxiety has been growing after Mr. Trump's surprise decision last week to fire FBI Director James Comey. Political uncertainty surrounding the Trump administration has been deflating investors' confidence in Mr. Trump's capability to deliver large fiscal stimulus, leading to reduced appetites for riskier assets.

The latest political crisis in Brazil was another factor sending Treasury yields lower earlier Thursday. Brazilian opposition lawmakers called on President Michel Temer to resign after a Brazilian newspaper reported Wednesday that Mr. Temer encouraged a top businessman to buy the silence of a jailed former congressional leader. The developments caused a selloff in Brazil's financial markets which rippled into many other emerging-market assets.

The bond market gave up its price strength after a bout of upbeat U.S. economic releases pointed to an improving economy.

The weekly jobless claims fell for a third consecutive week and hovered around a four-decades low, pointing to a robust labor market. Manufacturing in the Philadelphia region showed unexpected strength in May, according to the latest release from the Federal Reserve Bank of Philadelphia.

"The U.S. economy is still in good shape," said Jack McIntyre, portfolio manager at Brandywine Global Investment Management. "The key question is whether the political uncertainty is going to undermine the growth momentum."

In this environment, Mr. McIntyre said Treasury bonds offer "an insurance policy" in case U.S. stocks, which set record highs earlier month, suffer a large selloff.

The political uncertainty has given investors a fresh impetus to dial back the Trump, or reflation trade, which had dominated the global investing landscape since Donald Trump won the U.S. elections in November.

Mr. Trump's campaign promises of lower taxes, large infrastructure spending and lighter regulations have been the key factor driving investors to bet on stronger economic growth and higher inflation.

The bond market has been flagging a pullback of the Trump trade. After a big rise late last year, the 10-year Treasury yield has been falling this year. It was 2.446% at the end of 2016.

Bets on long-term Treasury debt have flipped into lower yields this month. That is a sharp departure from earlier this year when the consensus trade was that these yields would extend their postelection climb driven by the prospect of large fiscal stimulus.

Net bets wagering on higher prices or lower yields via the 10-year Treasury futures hit $ 22.9 billion for the week that ended May 9, according to TD Securities. That marked the highest since 2007. At the end of February, net bets wagering on higher yields had soared above $40 billion.

"Many are questioning their original expectations and are finding it difficult to predict where the markets will go, especially in Treasurys, " said Andrew Pace, vice president at Performance Trust Capital Partners LLC, a fixed-income trading firm. "The market could literally go any direction from here depending on what happens in the political landscape for the rest of the year, and investors should prepare for multiple scenarios to occur because anything can happen."

Some investors say the political developments out of D.C. aren't sufficient to delay an interest-rate increase by the Federal Reserve next month, unless the U.S. stock markets suffer a big selloff in the weeks ahead.

Fed-funds futures, used by investors to bet on the Fed's monetary policy outlook, showed 69% odds that the central bank would raise short term interest rates by its June 13-14 meeting, according to CME Group.

The odds rose from 65% Wednesday, though a week earlier they had been 83%.

Write to Min Zeng at min.zeng@wsj.com

(END) Dow Jones Newswires

May 18, 2017 11:13 ET (15:13 GMT)