BOND REPORT: 2-year Treasury Yield Post Largest Weeklong Decline Since April

Consumer price inflation for July at 0.1%, slightly below the consensus forecast of 0.2%

Short-dated yields slipped Friday, extending the largest five-day decline since April, after consumer-price inflation missed expectations, one of many anemic data releases this week that have cut into the odds that the Federal Reserve will push for an aggressive pace of monetary tightening this year.

The bid in Treasurys this week also gained momentum on geopolitical concerns over North Korea as investors scaled back risk and looked for shelter in haven investments like government paper and gold . President Donald Trump and the North Korean government have threatened to launch attacks on the other, elevating worries that the flare-up in tensions could prove different end up in war.

The 2-year Treasury yield fell more than 5 basis points to 1.286%, contributing to a weekly drop of 6.5 basis points, the biggest since April 13. Bond prices move inversely to yields.

The day's move for long-dated yields were more muted, with the 10-year Treasury note's yield slipping 2.1 basis points on Friday to 2.191%. It nonetheless fell nearly 8 basis points for the week. Likewise, the 30-year Treasury bond's yield traded flat at 2.790%, but posted a 5.3 basis point five-day drop.

Short-dated yields, sensitive to the vagaries of Fed monetary policy, plummeted on Friday after the Bureau of Labor Statistics reported that consumer-price inflation grew 0.1% in July, falling below the 0.2% gain forecast by economists surveyed by MarketWatch.

See: U.S. consumer inflation remains soft in July, CPI shows (http://www.marketwatch.com/story/us-consumer-inflation-remains-soft-in-july-cpi-shows-2017-08-11)

But some economists said market participants had focused too much on the headline figures and ignored the more significant trend within the mixed report.

"We're seeing some sort of stabilization [in core inflation] this year," said David Page, senior economist for AXA Investment Managers, pointing out some component gauges of consumer price data were susceptible to sharp movements in commodity prices.

Core CPI, which excludes volatile food and energy costs and of particular focus at the central bank, increased 0.1%. Consumer prices on a core basis stayed at an annual rate of 1.7%, close to the Fed's 2% long-term inflation target.

The steadying data could prove pivotal as senior Fed officials have shown concerns over the deterioration of core inflation from February to May, bearing out Fed Chairwoman Janet Yellen's prognostication that the weakness in consumer prices was transitory.

One puzzling reaction to the data was a widening of the spread between the 2-year Treasury note and the 30-year bond, a measure of the so-called yield curve that would suggest bond investors' expectations for inflation had actually risen. But Page said this could be simply down to investor positioning and short-term tactical trades, rather than a substantial change in the assessment of the economic picture.

Moreover, the widening yield gap was mostly driven by the steep fall in the yield for the 2-year Treasury note, reflecting expectations for a quarter-percent rate increase in December were rapidly diminishing. Traders ramped down their bets on higher interest rates for December, falling to 35.2% from 42.8% the day earlier, according to the Chicago Mercantile Exchange's FedWatch tool (http://www.cmegroup.com/trading/interest-rates/countdown-to-fomc.html/).

For all the hand-wringing over monetary tightening, analysts say senior Fed policy makers would likely sit on their decision for a rate increase this year to focus on preparing market participants for a the balance sheet's wind-down in the September policy meeting, the time when most investors expect the process to begin.

To signal a further rate increase in the face of lackluster data could risk stoking fears that a policy error could damage the U.S. economy's slow and steady expansion, said John Bredemus, fixed-income strategist for Allianz Investment Management.

Also read: Fed won't like soft July CPI data but has four months to get over it (http://www.marketwatch.com/story/fed-wont-like-soft-july-cpi-data-but-has-four-months-to-get-over-it-2017-08-11)

The morning data release had a pronounced impact on the dollar. The ICE Dollar Index , a gauge of the greenback's performance against a group of major currencies, fell more than 0.3% to 93.05. The weakening currency could, however, help inflation stage a rebound toward the tail-end of the year as tepid import prices have weighed on inflation measures (http://www.marketwatch.com/story/falling-import-prices-show-that-barely-any-inflation-is-coming-into-the-us-from-abroad-2017-07-18), said Page.

Traders also eyed a speech by Minneapolis Fed President Neel Kashkari, a voting member, with several senior Fed officials having already spoken this week (http://www.marketwatch.com/story/fed-risks-being-too-aggressive-on-rate-hikes-bullard-says-2017-08-09) on the inflation outlook. Kashkari spoke out against the monetary hawks--those in favor of normalizing interest rates at a quicker pace--who were telling a "ghost story" about higher wage inflation (http://www.marketwatch.com/story/feds-kashkari-says-central-banks-hawks-are-spooked-by-ghost-story-of-higher-wages-2017-08-11), even when there was no evidence it would "take off."

Elsewhere, inflation measures from eurozone members dragged bond yields in the economic bloc lower. Consumer prices in Spain slipped 0.7%, while falling in France by 0.35%. In addition, German 10-year government bonds, or bunds, fell to 0.380%, even as the country's inflation rate posted a sturdy 0.4% increase in July.

(END) Dow Jones Newswires

August 11, 2017 16:58 ET (20:58 GMT)