Bond Bulls Cheer as Dimmed Inflation Outlook Backs Gradual Fed

  • Treasury yields register first weekly decline in a month
  • Next week's releases include minutes of October Fed meeting

Americans’ long-term inflation expectations are the lowest in decades, giving bond traders reason to buy into the gradual path of interest-rate increases signaled by Federal Reserve officials.

Treasuries posted their first weekly gain in a month as economic data supported the slow approach. Consumers expect prices to rise 2.5 percent annually during the next five to 10 years, matching the lowest reading in statistics going back to 1979, a University of Michigan survey showed this week. The U.S. consumer price index barely rose in October from a year earlier, economists project before the figures’ release Nov. 17. Falling inflation expectations may suggest dimming confidence that the Fed can boost rates for the first time since 2006 without weakening the economy.

Inflation "is what the Fed has hung their hat on as giving them a basis to move forward," said Kevin McNeil, a rates strategist in Stamford, Connecticut, at RBS Securities Inc. "If we were to see further deterioration from these levels, that could give them pause."

Lower Yields

Benchmark 10-year note yields fell six basis points this week, or 0.06 percentage point, to 2.27 percent, after reaching a three-month high, according to Bloomberg Bond Trader data. The price on the 2.25 percent security due in November 2025, which the Treasury auctioned this week, was 99 27/32.

It was the biggest weekly drop in yields since early October. The brunt of the decline came Friday after data showed retail sales rose less than forecast in October and producer prices unexpectedly declined.

Next week, investors are looking to the Nov. 18 release of minutes from the Fed’s October meeting for a clearer picture of the debate among policy makers last month. Officials left their target near zero at the meeting and signaled that they’re assessing whether to lift it in December, leading traders to ramp up bets on a rate boost by year-end.

In a speech in New York on Thursday, New York Fed President William C. Dudley said the conditions for liftoff “could soon be satisfied.” He also said the Fed’s preferred gauge of price pressures was “substantially” short of its target.

Futures contracts signal a 66 percent chance that officials will raise rates by year-end, compared with 68 percent at the end of last week. The calculations assume the benchmark will average 0.375 percent after the first increase, versus the current target range of zero to 0.25 percent.

"The market pricing of rate hikes hasn’t really changed," said Subadra Rajappa, head of U.S. rates strategy at Societe Generale SA in New York. "But we think even if they hike in December, the message will be somewhat dovish."

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