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Bond Report: 2-year Treasury leads decline in U.S. yields on dearth of market-moving economic news

Treasurys rallied on Thursday, driving most yields modestly lower, in moves that traders attributed to a range of factors including comments by a European Central Bank member, the prospects of U.S.-Taiwan trade talks, and Japanese demand for U.S. government bonds.

What’s happening

The yield on the 2-year Treasury

slipped  6 basis points to 3.233% from 3.293% on Wednesday.

The yield on the 10-year Treasury

declined 1.5 basis points to 2.879% from 2.894% on Wednesday afternoon.

The yield on the 30-year Treasury

fell less than 1 basis point to 3.139% from 3.146% late Wednesday.

What’s driving markets

The U.S. produced a lack of market-moving news on Thursday. Data released on Thursday showed that initial jobless claims fell by 2,000 to 250,000 in the first week of August, suggesting no signs of a surge in layoffs. Meanwhile, business activity among Philadelphia-area manufacturers expanded in August, but demand continues to be weak, according to data from the Federal Reserve Bank of Philadelphia. And existing home sales fell almost 6% in July.

The dearth of major U.S. economic data had traders focused elsewhere. In Europe, European Central Bank board member Isabel Schnabel said the region’s inflation outlook has failed to improve, suggesting she favors another large interest rate increase even as recession risks firm.

And in geopolitics, the U.S. agreed to hold trade talks with Taiwan in a new show of support for the island, which is battling tensions with its large neighbor China. That development “could be underpinning some strength” in bonds, said Larry Milstein, senior managing director of government debt trading at R.W. Pressprich & Co.

Separately, demand for government bonds could be seen from Japanese investors and the 10-year yield has recently been hovering around the attractive level of 2.9%, a second trader said. Meanwhile, Treasury’s $8 billion auction of 30-year TIPS produced “the largest stop through on record,” according to BMO Capital Markets strategist Ben Jeffery.

Yields had moved higher on Wednesday after data showed the annual rate of inflation in the U.K. breached 10% for the first time in more than 40 years, raising fears that many economies have yet to register peak inflation.

In addition, minutes of the Federal Reserve’s July policy meeting showed that although the central bank was wary of overtightening policy, it was nevertheless in no mood to stop raising interest rates as it seeks to damp an annual U.S. inflation rate running just shy of a 41-year high.

Read: Did the stock market ‘misinterpret’ Fed again? What strategists say about the reaction to the July minutes

A handful of Fed officials emerged on Thursday with fresh remarks. San Francisco Fed President Mary Daly said the Fed doesn’t want to “overdo” rate hikes, while James Bullard of the St. Louis Fed said he’s leaning in favor of supporting a 75 basis point hike in September. Kansas City’s Esther George said the case for continuing to raise rates “remains strong.” Meanwhile, Neel Kashkari from the Minneapolis Fed said he doesn’t know if the central bank can bring inflation down without triggering a recession.

Markets are pricing in a 58.5% probability that the Fed will raise interest rates by another 50 basis points to a range of 2.75% and 3% at its Sept. 20-21 meeting. The central bank is mostly expected to take its borrowing costs to between 3.5% and 3.75% by next March, according to fed funds futures traders.

What analysts are saying

“We got to a level of around 2.9% on 10-year notes and held, and that’s really why we’re rallying,” said trader Tom di Galoma of Seaport Global Holdings in Greenwich, Connecticut. In addition, there’s been “decent allocation from Japan back to the U.S. and there seems to be a number of large Japanese accounts that are buying Treasurys.”

Meanwhile, given risk-off moves in stocks on Thursday, “people are still trying to figure out what the Fed does,” with the notion that policy makers could “go either way” when it comes to hiking rates by either 50 or 75 basis points at their next meeting, he said.

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