Bond Report: U.S. government bond yields slip, while the yield curve tightens ahead of import, sentiment reports

Treasurys drew bidders early Friday, pushing prices up and nudging yields down, after one measure of inflation on Thursday showed that prices weren’t rising at a pace that might prompt the Federal Reserve to adopt a more aggressive path of rate increases in 2018 that anticipated.

Traders also focused on a narrowing gap between the rates between short-dated and long-dated government paper as a gauge of the market’s outlook for the economy.

How are Treasurys performing?

The 10-year Treasury note yield TMUBMUSD10Y, -0.06% slipped by 2 basis points to 2.951%, and the 2-year note yield TMUBMUSD02Y, +0.35% the most sensitive to shifting expectations on monetary policy, edged 0.7 basis point lower to 2.531%.

Meanwhile, the 30-year bond yield TMUBMUSD30Y, -0.54% gave up 2.2 basis points to 3.098%, and the yield for the 5-year Treasury note TMUBMUSD05Y, +0.18%  edged down by 0.8 basis point to 2.825%.

The yield spread between the 5-year and the 10-year was 27.3 basis points, or 0.273 percentage points, after hitting its flattest since July 2007 on Thursday, while the gap between the 2-year and the 10-year rate stood at 42 basis points, around its lowest in about a decade.

The yield curve is often tracked as a measure of sentiment about the economy’s overall health. In a normal environment, the yield curve steepens because investors tend to demand a higher yield for lending further into the future, while a flattening curve is read as a sign that investors are worried about the longer-term outlook.

For the week, the three main maturities saw mixed action, with the 10-year yield edging up 0.5 basis point thus far on Friday, while the 2-year note yield has climbed by 3.3 basis points, and the 30-year bond has slipped 1.9 basis points.

What’s driving the market?

Signs of tepid inflation, which is when elevated can erode the value of a bond’s fixed payments, helped to drive some buying in government paper, pushing yields lower.

On Thursday, consumer-price inflation data for April rose 0.2%, below the forecast of a 0.3% increase from economists polled by MarketWatch. Its core gauge, stripping out volatile food and energy prices, rose 0.1%, keeping its yearly increase at 2.1%

The thinking is that the U.S. central bank may not have to increase rates at a faster clip than the two increases that Wall Street is anticipating for 2018.

Meanwhile, yields of longer-dated bonds have compressed somewhat against their shorter-dated counterparts in the face of a series of bond auctions, with investors successfully taking down a $ 17 billion auction of 30-year bonds Thursday afternoon, which followed a $ 25 billion sale of 10-year notes produced on Wednesday. All totaled, about $ 73 billion in government debt was sold amid growing deficits that have prompted the Treasury Department to ramp up issuance this year.

Bond traders also were paying attention to political developments in Europe, with Italy’s far-right League party and populist 5 Star Movement moving closer to creating a coalition government, potentially putting an end to more than two months of political gridlock, but also putting in power antiestablishment parties that could roil the eurozone in the future.

Against that backdrop, the yield on 10-year Italian government bonds TMBMKIT-10Y, -3.62% declined by 3 basis points to 1.901%, after earlier in the week touching its highest level since mid-March as investors sold off Italian debt.

What are strategists saying?

“The combination of lower than expected inflation and overall good demand at this week’s refunding drove the US curve flatter. The 2/10Y was 4bp down, reaching 43bp and the 5/30, another closely watched measure of the curve shape, fell to 28bp,” wrote analysts at UniCredit in a Friday report.

“Strictly speaking, this is the lowest level since September 2007 although at that time the curve was already in bull steepening mode. A better reference is early 2007, when the Fed policy rates were at the peak of the tightening cycle. As we have been arguing for some time, we expect curve flattening to continue in the coming quarters,” the analysts wrote. A bull steepener refers to changes in the yield curve caused by short rates falling faster than their longer-dated counterparts.

What data and Fed speakers are in focus?

A report on import prices for April is due at 8:30 a.m. Eastern Time, while St. Louis Fed President James Bullard is due to deliver a speech on economic and monetary policy to the Springfield Area Chamber of Commerce in Missouri at around the same time. Bullard isn’t currently a voting member on the rate-setting Federal Open Market Committee.

Later, the University of Michigan’s consumer-sentiment index for May is expected at 10 a.m.

Which assets are also in focus

The yield for the 10-year German bond TMBMKDE-10Y, -0.47%  was at 0.533% little changed from its levels on Thursday. German sovereign paper serves as a benchmark for the overall eurozone bond market.

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