U.S. Treasurys End August with a Whimper

U.S. government bonds ended a volatile month with a whimper Monday as priced pulled back on the prospect of upbeat economic data and tighter Federal Reserve policy.

The Treasurys market chipped away at gains throughout the session as typical month-end buying gave way to renewed focus on the U.S. economy, bond traders said. Prices slipped to session lows by late afternoon, with benchmark 10-year notes down 5/32 to yield 2.204%--almost exactly where it started the month. Bond yields rise when prices fall.

"Fundamentally, the U.S. economy is growing at a healthy pace," said Ninh Chung, head of investment strategy and portfolio management at SVB Asset Management. "Directionally, we should see higher yields even though we'll have volatile swings. The premise is that the Fed is closer to normalizing monetary policy."

Monday's losses in Treasurys capped a volatile month that had the 10-year yield trading as low as 1.90% just a week ago and as high as 2.30% in early August. Bond investors entered the month bracing for decent U.S. economic data to support the case for an interest-rate increase by the Fed in September. That was until China's central banks devalued its currency on Aug. 11, calling attention to its decelerating economy and how that might hurt global growth.

Since then, concerns about the global economy and disinflationary pressures have fueled bouts of buying in Treasurys, all while several Fed officials maintained that a rate increase in 2015 remains on the table. Bond traders said that was also the takeaway from the Fed's conference over the weekend in Jackson Hole, Wyo.

"The key messaging from Jackson Hole speakers remained that while inflation may be too low, the outlook for growth and the labor market momentum remain favorable and that the possibility of a 2015 rate hike still cannot be excluded," says Gennadiy Goldberg, a U.S. strategist at TD Securities.

The fact that a rate increase remains in play this year has put pressure on shorted-dated notes, which are most vulnerable to the prospect of tighter monetary policy. Two-year notes lost a fraction on Monday to yield 0.739%, pushing the rate up in August for the fifth straight month. August's 0.063 percentage-point rise is the biggest one-month increase since February.

Bond traders said the pressure on short-end notes should build, with the Fed's Sept. 17 policy announcement now just a few weeks away. Calmer financial markets and any positive signals from economic data would increase expectations for the Fed to pull the trigger next month and deliver its first rate increase in nearly a decade.

To help shape those expectations, investors are focusing on this week's spate of economic data, especially Friday's nonfarm payrolls report. The median expectation from economists surveyed by The Wall Street Journal is for a net gain of 220,000 jobs in August and an unemployment rate of 5.2% from 5.3% in July.

Such a result, market strategists say, would reflect ongoing improvements in the U.S. labor market and support calls for the Fed to tighten policy in September.

Meanwhile, the tone in longer-dated Treasurys is somewhat rosier, bond traders noted, even with Monday's losses. The continuing lack of inflation sets up a friendly environment for longer-maturity bonds, and a Fed rate increase would only clamp down further on pricing pressure.

"The slow pace of inflation suggests lower long term rates, which may continue to be supported by flight-to-quality investors," said Sharon Stark, fixed-income strategist at D.A. Davidson.

Despite Monday's rise in yields, the 10-year rate managed to post its second straight monthly decline -- a reflection of appetite for U.S. bonds given their relatively juicy yields compared with safe-haven government debt. Germany's 10-year debt yielded 0.803% late Monday.

   COUPON   ISSUE    PRICE      CHANGE     YIELD    CHANGE

   5/8%     2-year   99 25/32   dn 0/32    0.739%   +1.2BP

   1%       3-year   99 27/32   dn 2/32    1.051%   +1.9BP

   1 5/8%   5-year   99  6/32   dn 3/32    1.546%   +2.3BP

   2%       7-year   99 18/32   dn 5/32    1.940%   +2.7BP

   2 1/8%   10-year  98  6/32   dn 5/32    2.204%   +1.6BP

   2 1/2%   30-year  98 16/32   dn 27/32   2.960%   +4.4BP

   2-10-Yr Yield Spread: +146.5BPS +146.1BPS

  Source: Tradeweb/WSJ

(By Cynthia Lin)