US bonds rally further on Fed's inflation assurance

US 30-year Treasury bonds rallied on Monday, pushing yields to four-month lows, as investors remained heartened by last week's assurances that the Federal Reserve will preempt inflation before it takes off. Fed Governor Kevin Warsh said on Friday the central bank may begin to tighten its super-loose monetary policy before it is clearly necessary, assuaging concerns that high inflation would result from its near-zero percent interest rates.
Warsh's comments pleased bond investors, particularly as they came after the Fed said in its latest policy statement that it would keep rates low for an extended period while the economy recovers from the worst recession in decades. Taken together, the message seems to be that the Fed wants to get the economy going but will not tolerate inflation or the boom-and-bust cycles that were prevalent under former Fed Chairman Alan Greenspan, analysts said.
"Maybe the bond vigilantes feel like they are winning. The worst-case scenario of the Fed keeping their foot on the accelerator forever perhaps is not on the table any longer," said David Dietze, chief investment strategist at Point View Financial Services, in Summit, New Jersey.
"They are going to be more disciplined than we saw perhaps in the Greenspan years. Inflation does matter to them...therefore we can be more comfortable with Treasuries, particularly longer dated ones," he said. The 30-year long bond was last up 1-2/32 on the day, yielding 4.03 percent versus Friday's 4.09 percent. The yields were the lowest since mid-May.
Long bonds are particularly sensitive to inflation due to uncertainty over holding them for 30 years. Inflation erodes the value of bonds as well as their cash flows. Benchmark 10-year notes were up 9/32 yielding 3.29 percent, their lowest in two weeks. At the short end, two-year notes were flat in price, yielding 0.98 percent. The outperformance of longer maturities narrowed the difference in their rates with shorter-dated debt, or flattened the yield curve. The curve is at its flattest since May, based on the difference between two- and 10-year yields. In a comparison of two- and 30-year yields the curve is its flattest since late April.