Treasury yield falls below 2% as stock rout drives safety demand

[LONDON] US 10-year Treasury yields dropped below 2 per cent for the first time since April, as a sell-off in stocks and commodities boosted demand for the safest fixed-income assets.

US government securities rose for a fourth day amid concern slowing growth in China will suppress economic momentum around the world and deter the Federal Reserve from raising interest rates this year. A bond-market gauge of inflation expectations dropped for a sixth day and touched the lowest level since January.

"With equities plummeting since last week, the knee-jerk reaction for markets has to be reducing the odds of Fed hikes and increasing the odds of rate cuts elsewhere in developed markets," said Richard Kelley, head of global strategy at Toronto Dominion Bank in London.

"Bond yields are falling as a result, but until we know what the Chinese central bank's response will be, it's hard to tell what the lasting contagion into developed markets will actually be."

The benchmark US 10-year note yield fell four basis points, or 0.04 percentage point, to 2 per cent as of 7:06 am New York time, according to Bloomberg Bond Trader data. It earlier touched 1.97 per cent, the lowest since April 28. The 2 per cent security due in August 2025 rose 11/32, or US$3.44 per US$1,000 face amount, to 100.

China equities led declines in Asian stocks with the Shanghai Composite Index slumping as much as 9 per cent, wiping out this year's gains. The Bloomberg Commodity Index, which tracks 22 raw materials, fell to the lowest level since August 1999. Haven assets such as the yen, Swiss franc and gold rallied.

"We are seeing risk-off moves in the form of a stronger yen, Swiss franc and gold, and US Treasuries have also been a great recipient," Kay Van-Petersen, a strategist at Saxo Capital Markets in Singapore, wrote via electronic messaging.

He said it was hard to say what prompted the latest market moves, though a "combination of being in summer mode, light volumes, lots of people off desk" may be blamed.

Futures traders cut odds to 30 per cent that the Fed will raise interest rates at its September meeting, from a 48 per cent probability on Aug 14. The chance of a December increase fell to 54 per cent from 74 per cent. The figures are based on the assumption that the effective fed funds rate will average 0.375 per cent after the first increase.

The Fed should focus on what's best for the economy rather than try to please investors, Saxo's Mr Van-Petersen said.

"The very worst thing they could do is let the market dictate what they should do," he said.

"If they don't raise this year, after delaying it from March to April to now September, then no one will believe whatever they say in the future."

Although Treasury 10-year yields have dropped below 2 per cent, they are unlikely to stay below that level, according to Hideaki Kuriki, who invests in Treasuries at Sumitomo Mitsui Trust Asset Management in Tokyo.

"It's not just Treasuries which are being bought, buying is also diversified into the yen and the euro, suggesting market moves are partly due to positioning," he said.

"The 10-year yield won't head towards 1.50 per cent. Declines will likely be temporary and I see 2 per cent as the limit."

The extra yield on benchmark 10-year notes over those on similar-maturity inflation-linked debt shrank to as little as 1.51 percentage points, the least since January. The gauge is a measure of inflation expectations over the life of the securities.

BLOOMBERG