Treasuries outlook: yield curve flattens on stronger US economic data

The US yield curve flattened to the lowest levels in two months on Friday after data showed US retail sales rose the most in a year in April, suggesting the economy was regaining momentum after growth almost stalled in the first quarter. The Commerce Department said retail sales jumped 1.3 percent last month, the largest gain since March 2015. This March's retail sales were revised up to show a 0.3 percent decline instead of the previously reported 0.4 percent drop.
"Across the board it was stronger than anticipated," said David Ader, head of government bond strategy at CRT Capital in Stamford, Connecticut. Short- and intermediate-dated debt underperformed long-dated bonds after the data, putting the two-year, 10-year yield curve at its flattest levels since March 8. The yield curve flattened to 94.5 basis points, from 97 basis points before the data was released.
The curve has flattened since Boston Federal Reserve President Eric Rosengren, a voting member this year on the Fed's rate-setting committee, said on Thursday that the market is too pessimistic about the economy and the likelihood of further tightening. "Rosengren was somewhat hawkish that started the flattening of the curve that has continued today," said Dan Mulholland, head of Treasuries trading at Credit Agricole in New York.
Longer-dated debt was also well bid as stock and oil prices declined and German sovereign debt rallied. Treasury yields have fallen for the past two-and-a-half weeks on concerns about slowing global growth and tepid inflation.
Benchmark 10-year notes rose 16/32 in price on Friday to yield 1.71 percent, down from 1.76 percent on Thursday. The yields have fallen from 1.94 percent on April 26. Investors and Fed officials have starkly different expectations of economic growth, with most Fed officials pointing to the likelihood of further rate hikes this year while market pricing indicates an increase will not occur until early 2017.
"The Fed universally has been at a disconnect with the market for a very, very long time," said Ader. "The market has been much more prescient in terms of anticipating the Fed." US producer prices also rose in April as energy prices increased, but a marginal gain in the cost of services pointed to a moderate increase in inflation in the coming months. US business inventories rose more than expected in March as automobiles recorded their biggest increase since 2013, suggesting that the first-quarter's weak economic growth estimate could be revised higher.