Long-dated US government bond prices fell on Thursday as investors were reluctant to make large bets on further yield falls, after a dramatic rally this month on slowing global growth saw the debt test record low yields. Benchmark 10-year note yields are trading only 8 basis points higher than a record low of 1.44 percent set on June 1, which were tested again earlier this week when surprisingly weak economic data spurred new bond buying.
Investors are now waiting on further confirmation of the direction of the economy and whether it will weaken enough to spur the Federal Reserve into launching a new round of quantitative easing. "It doesn't feel like we're ready to break those record levels yet," said Justin Lederer, interest rate strategist at Cantor Fitzgerald in New York. "It feels like the market is priced in for weak data."
New signs of slowing US economic growth on Thursday initially caused bonds to erase losses, and follow gains in stocks and other risk assets. US jobless claims jumped last week, while existing-home sales unexpectedly fell. The Philadelphia Federal Reserve said its index of business activity in the Mid-Atlantic region showed contraction again.
That, however, did not stem prices from falling again in the afternoon. Prices dropped after the Treasury saw solid demand for a $15 billion sale of new 10-year Treasury Inflation Protected Securities (TIPS), which sold at record negative yields of minus-0.637 percent.
Analysts attributed the price falls to hedging by dealers relating to TIPS buying in the auction, where they took around 40 percent of the sale. The two-year note yield, meanwhile, touched its lowest level since late January on growing bets that the Fed would lower the interest rate it pays banks on excess reserves they deposit with the Fed, analysts and traders said.
Thursday's data, while not spurring a broader bond rally, increased some expectations that the Fed will need to act to stimulate the economy. "These are disappointing data. This pushes the possibility of QE3 higher," said Wilmer Stith, who co-manages the $300 million Wilmington Broad Market Bond Fund in Baltimore.
Fed Chairman Ben Bernanke has said that lowering rates on excess reserves is one possible action the Fed could take to stimulate growth. Last week the European Central Bank dropped its deposit rate on excess bank reserves to zero. Expectations the Fed would follow the ECB's move pushed the two-year note yield as low as 0.214 percent, the lowest level since January 30, according to Reuters data.
That said, many investors and economists have downplayed the chances of such a move because it could hurt US money market funds and disrupt the dollar funding market. Increased bets on a cut in interest on excess reserves may also help a new sale of two-year notes scheduled for next week, analysts said. The Treasury said on Thursday it will sell a combined $99 billion in two-year, five-year and seven-year notes next week, starting on Tuesday.