Bond Report: 10-year Treasury yield comes full circle as 2017 comes to close

Treasury yields mostly fell on Friday in holiday-thinned trade as U.S. government paper ended slightly below levels seen at the beginning of the year.

The bond market closed early Friday, at 2 p.m. Eastern, and will be closed on Monday for New Year’s.

What are Treasurys doing?

The 10-year Treasury yield TMUBMUSD10Y, -0.96% fell 2.3 basis points to 2.409%, a few basis points from 2.45%, where the benchmark maturity stood at the year’s start. The 30-year bond yield TMUBMUSD30Y, -0.44%  ticked lower 1.4 basis point to 2.742%.

It was shorter maturities that showed the biggest moves this year after the Federal Reserve raised three times during the year. The 2-year note yield TMUBMUSD02Y, -0.84% which is more sensitive to changes in monetary policy, fell 2.8 basis points to 1.883% on Friday, but rose close to 70 basis points in 2017.

Bond prices move in the opposite direction of yields.

What’s driving the market?

Treasury yields have generally returned slightly below where they started in 2017 as the absence of inflation kept a lid on bond yields. Even three interest-rate hikes by the Federal Reserve failed to push up the 10-year yield, as traders became convinced the central bank was willing to tighten monetary policy regardless whether inflation touched 2%.

Hopes for President Donald Trump’s administration to drive inflation higher through fiscal policy have diminished as the White House struggled to pass legislation throughout the year. But when the tax bill passed in December, it failed to draw enthusiasm from bond investors, with many saying its economic benefits appeared less clear-cut than advertised.

Investors say the direction of the bond market next year will also hinge on whether growth and inflation will pop up in Europe and Japan, allowing their central banks to take their foot off the easing pedal. Reduced stimulus from the Bank of Japan and the European Central Bank could give long-term yields room to run higher, and the opportunity for the yield curve to steepen.

The yield curve is a line tracing a bond’s maturities and its yields. A flatter curve can be a harbinger of an economic downturn while a steeper curve can suggest a strengthening economic outlook. But analysts say its predictive abilities have waned as bond-buying from global central banks distorts the curve’s dynamics.

What are market participants saying?

“Choosing a curve-shape camp boils down to one fundamental question: What is the sustainable growth in GDP in developed Western economies without central bank stimulus?” wrote Jim Vogel, interest-rate strategist for FTN Financial.

“Should Eurozone or Japanese core inflation readings begin to surprise to the upside systematically markets would quickly reprice the current super-easy monetary policy accommodation from the ECB and the BOJ,” wrote credit strategists at Bank of America Merrill Lynch, in a note dated Dec. 27.

Which other assets are in focus

Italian bonds extended their decline on the last day of the year after President Sergio Mattarella called a general election for next year. Polling shows anti-establishment parties such as the Five-Star Movement have amassed broad support, raising the chance of a hung parliament. That could lead to political inertia and delay reforms for one of the eurozone’s economic laggards.

The Italian 10-year government bond yield TMBMKIT-10Y, +2.16% rose 5 basis points to 2.005% while the German 10-year bond yield stood at 0.424% according to Tradeweb data. The yield premium between riskier Italian paper and Germany’s safer counterparts has widened to 1.58 percentage point.

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