By William Watts, MarketWatch , Sunny Oh
Supply worries, inflation concerns pushed up yields, contributing to the equity selloff
Treasury yields pulled back from their highs on Friday as stocks swung back into positive territory but posted their worst week since 2016.
That contributed to an overall rally seen in bond markets for the week as investors downgraded their expectations for further rate increases from the Federal Reserve.
What yields doing?
The 2-year note yield, sensitive to shifting expectations for Fed policy, fell 7.3 basis points to 2.061%, the biggest one-day drop since June 2016, adding to a 9.2 basis point decline this week. The 30-year Treasury bond rate was off 0.5 basis point to 3.137%, but up 3.9 basis points for the week.
The yield on the 10-year Treasury note was down 2.2 basis points to 2.829%, contributing to nearly all of the weekly fall of 2.3 basis points. The yield hit a four-year high of 2.880% on Monday.
Yields move in the opposite direction of debt prices.
What's driving the market
Yields saw their climb erased on Friday as U.S. stocks swung between gains and losses, reflecting the tug of war between a classic flight to quality response and growing fears bonds are in a bear market.
But overall, elevated yields have been blamed for kicking off a stock market rout that's left the Dow Jones Industrial Average and the S&P 500 with its worst week since Jan. 2016.
The 10-year yield has stayed close to a four-year high on a variety of concerns raging from rising inflation expectations, expansionary fiscal spending and rising bond issuance.
Stronger-than-expected wage growth data for January last week stoked inflation expectations, underlining worries the Federal Reserve would prove more aggressive than anticipated in lifting interest rates. Stronger price pressures can erode the value of a bond's fixed interest payments.
Yet in the strange interplay between equities and bonds this week, a stock selloff could put a pause on the central bank's rate hike trajectory by tightening financial conditions. Last year, senior Fed officials often cited easy financial conditions as one reason for delivering further rate increases. Those concerns were reflected in the sudden slide in the 2-year yield, which has relentlessly climbed in the last few months over expectations for tighter monetary policy.
President Donald Trump signed off on a two-year budget deal (http://www.marketwatch.com/story/senate-passes-budget-deal-as-government-remains-shut-down-2018-02-09) on Friday that raises both military and domestic spending and ended a brief government shutdown. That could prove ill-timed when the economy is already nearing full capacity and further fiscal stimulus could cause growth to overheat.
Read:With federal spending on the loose, are bond vigilantes set to make a comeback? (http://www.marketwatch.com/story/with-federal-spending-on-the-loose-are-bond-vigilantes-set-to-make-a-comeback-2018-02-09)
The deal is expected to add to the deficit. Analysts at Bank of America Merrill Lynch boosted their fiscal 2018 and 2019 deficit forecast by $35 billion and $20 billion, respectively. That would put the 2018 gap at $825 billion and the 2019 deficit at $1.07 billion.
Treasury issuance was already set to rise this year before the passage of a sweeping tax overhaul in December that's slated to significantly add to the deficit.
What are analysts saying?
"We continue to argue that accelerating inflation, robust growth outlook and expansive financial conditions facilitate continued Fed rate hikes (we now expect four this year) and together with an increasing bond supply speaks in favor of higher U.S. rates," said Lina Fransson, fixed income strategist at SEB in Stockholm, in a note.
"The one thing we're paying to is in the last few days, with the equities selloff, how that has tightened financial conditions. It could pressure off the Fed to hike more than three times in 2018," said Craig Bishop, lead strategist for U.S. fixed-income strategies for RBC Wealth Management.
What else is on investors' radar?
Kansas City Fed President Esther George said the recently passed fiscal stimulus will push the central bank to continue on its rate hiking trajectory, Reuters reported (https://www.reuters.com/article/us-usa-fed-george/feds-george-says-fiscal-stimulus-means-rate-hikes-important-idUSKBN1FT096?il=0).
(END) Dow Jones Newswires
February 09, 2018 17:13 ET (22:13 GMT)