Yield spreads between shorter-dated and longer-dated Treasuries contracted on Friday as traders added to bets the Federal Reserve would wait until the end of the year to raise rates and focus on its balance sheet at next week's policy meeting. North Korea's latest missile launch over Japan and a bomb explosion in the London subway were shrugged off by financial markets.
Longer-dated Treasury yields held steady, supported by surprise drops in domestic retail sales and industrial output in August, seen partly because of Hurricane Harvey, which revived some concerns about economic growth in the third quarter. "It's a bit of pricing out of the extreme dovishness in the front part of the yield curve," Boris Rjavinski, senior rate strategist at Wells Fargo Securities in New York said of the flattening of the yield curve.
The yield spread between five-year and 30-year Treasuries contracted to 96 basis points, the tightest since July 7, from 103 basis points a week earlier, Tradeweb data showed. Friday's disappointing US data came after a report earlier this week that showed the strongest increase in consumer prices in seven months, snapping a string of below-forecast readings.
The consumer price index's 0.4 percent rise in August revived bets the Federal Reserve would raise key short-term borrowing costs at its December 12-13 policy meeting, lifting shorter and medium Treasury yields. "There is more optimism about a possible December rate hike after the latest CPI number," said Larry Milstein, head of agency and government trading at R.W. Pressprich & Co in New York.
Interest rates futures implied traders saw as high as 58 percent chance on a December rate increase before finishing at 53 percent. This compared with 31 percent a week earlier, CME Group's FedWatch tool showed. Fed policymakers are unlikely to change their cautious stance on raising rates as they are widely expected to focus on rolling out their plan to scale back the central bank's $4.2 trillion bond holdings at next week's meeting, analysts said.
Traders also await policymakers' outlook on rates and the economy as well as possible assessments of the impact from Hurricanes Harvey and Irma. Industrial production fell 0.9 percent in August, its first decline since January, and retail sales slid 0.2 percent last month as Hurricane Harvey disrupted activity. The benchmark 10-year yield was 2.201 percent, up marginally on the day. It hit a three-week peak at 2.225 percent on Thursday.
The yield on two-year Treasury notes was up 1.6 basis points at 1.384 percent. It touched 1.388 percent for a second time earlier Friday, which was its highest since July 26, Reuters data showed. US debt supply was heavy this week with the Treasury selling $56 billion of coupon-bearing supply. This was nearly matched by companies that issued some $55 billion in high-grade and junk bonds, according to IFR, a Thomson Reuters unit.