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US$131b of Treasuries with lowest yields on offer

US-China trade impasse has put global economic growth in question and is driving investors to the safety of Treasuries; tame inflation expected to bolster demand

New York

A US$131 billion deluge of Treasury notes is about to hit with yields at their lowest in more than a year. But bond traders can take heart: This week is also expected to bring confirmation that inflation remains tame, which could bolster demand.

The trade impasse enveloping the US and China has put global economic growth in question, and is driving investors to the safety of Treasuries. The yields on maturities that the Treasury Department will offer - two-, five- and seven-year notes - are the lowest since at least early 2018.

Arguing against a big jump in yields amid the auctions: The latest reading of the Federal Reserve's preferred inflation gauge, set for release May 31, is forecast to remain well below officials' 2 per cent target. That backdrop is fostering scepticism about the central bank's view that the forces depressing price pressures will prove "transitory", and is fuelling bets on rate cuts by year-end.

Market voices on:

"There is a lot riding on the assumption, and the hope that the fall in inflation is due to temporary factors and that they'll reverse," said Antoine Bouvet, an interest rate strategist at Mizuho International plc. "If this fails to be the case, then you can expect the Treasury rally to continue."

Ten-year Treasuries yield 2.32 per cent, close to the lowest since late 2017, amid escalating trade tensions and signs of slowing global growth. The benchmark for everything from mortgages to car loans is down from 3.26 per cent in October, leaving it below the rate on three-month bills. An inversion in that gap is historically seen as a precursor to recession.

Traders are betting that the Fed will act in the coming months, even as officials say that they can be patient on rates. Derivatives show that the market is pricing in more than a full quarter-point Fed cut this year, with some wagers emerging that the first step will be a half-point reduction.

Minutes from the Fed's April 30-May 1 meeting confirmed that many officials agreed with chairman Jerome Powell's description of low US inflation as resulting from transitory forces. Since introducing its 2 per cent target in 2012, the central bank has failed to lift inflation to that level on a sustained basis.

The personal consumption expenditures price index - the Fed's favoured inflation gauge - rose 1.5 per cent in March from a year earlier, and is seen climbing 1.6 per cent in April, according to the median forecast in a Bloomberg survey.

And with US President Donald Trump and Chinese President Xi Jinping seemingly far from a deal as other geopolitical concerns are percolating, the Treasury may avoid paying up as it offers fixed- and floating-rate coupon debt starting on Tuesday.

"The decline we've seen in Treasury yields has been more related to safe-haven flows than economic weakness," said Michael DePalma, a portfolio manager at MacKay Shields, which oversees US$91 billion. "You'll probably will see demand for the new Treasury supply given this environment. People are snapping up debt."

US markets will close for the Memorial Day holiday on Monday. But traders will be monitoring trade dealings between China and the US, as well as Mr Trump's discussions with Japanese Prime Minister Shinzo Abe during meetings this week in Tokyo. There is also a Bank of Canada decision set for May 29. BLOOMBERG