By Min Zeng
U.S. Treasury bonds rallied Thursday as a flat reading in U.S.
wage inflation bolstered expectations that the Federal Reserve
would continue to be patient in raising interest rates.
The nonfarm employment report caught many investors off guard.
Bond prices had sold off as economists had expected a gain in wage
growth along with solid jobs expansion. Many data over the past few
months have showed the U.S. economy is picking up speed after a
shallow contraction during the first three months of the year.
The report not only showed a setback in wage growth but the pace
of jobs growth--223,000--also slightly trailed market expectations.
Many investors say the report doesn't buck the trend of an
improving economic outlook, but it did bolster the case for the Fed
to continue to monitor data before it starts raising benchmark
short-term interest rates.
The prospect that the Fed may keep interest rates lower for
longer encouraged investors to buy bonds. Investors and traders who
had positioned for lower bond prices were forced to buy bonds to
cover soured wagers.
The price rally sent the yield on the benchmark 10-year Treasury
note to as low as 2.368%, compared with 2.47% right before the
report which was near a nine-month peak. Yields fall as prices
rise.
In recent trading, the yield was 2.379%. It was 2.416%
Wednesday.
"The report didn't meet lofty expectations and turned the bond
market around," said Mike Lorizio, senior fixed income trader at
Manulife Asset Management which has $383 billion Canadian dollars
($304.8 billion) in assets under management. "The Fed needs to see
inflation continue to move from low levels before raising interest
rates."
After a strong price rally during the first quarter, demand for
ultrasafe U.S. government debt has soured, sending bond yields
higher over the past few months. Sign of improving growth outlook
in the U.S. and Europe, fading worries over deflation in the
eurozone and growing concerns over bonds' valuations all soured
demand on the haven debt market.
Many investors have been shedding their bondholdings to prepare
for the Fed's rate-increase campaign for the first time since 2006.
They are concerned that the Fed's tightening campaign would shrink
the value of outstanding bonds.
Fed officials have been cautious in shifting into higher
interest rates. Inflation indicators have been running below their
2% target. Global growth outlook remains uneven. The uncertainty
over Greece's debt crisis, which has fueled broad market swings
over the past few month--complicated the Fed's deliberations.
Fed-funds futures, which are used to place bets on central bank
policy, showed Thursday that investors and traders see a 10%
likelihood of a rate increase at the September meeting, compared
with 17% before the jobs report, according to CME Group.
The odds for a rate increase at the December meeting were 49%,
compared with 59% before the data.
Zhiwei Ren, managing director and portfolio manager at Penn
Mutual Asset Management Inc., which has $20 billion assets under
management, said a rate increase in September can't be completely
ruled out.
Mr. Ren said he is sticking to his positioning for higher bond
yields. Friday's jobs report "is a one-off and inconsistent with
other reports on a stronger economy," he said. "This doesn't change
the big picture of the U.S. economy."
The U.S. bond market will be shut on Friday to observe the
Independence Day holiday. In the near term, analysts say investors
need to gird for more volatility in financial markets ahead of the
Sunday referendum on whether Greece will accept austerity measures
demanded by creditors in exchange for further aid.
"It is uncharted territory," said Erik Weisman, portfolio
manager at MFS Investment Management, which has $450.4 billion
under management at the end of May. "You had better keep your
position close to home due to the uncertainty.
Mr. Weisman said Treasury bonds could sell off if Greek people
vote yes to the referendum as this would be perceived as a
dial-back of the debt crisis. A "no" vote would generate a fight
into Treasury debt, he said. But he added that if this outcome
leads to a change in Greek government and a more willing leadership
to reach a resolution, it could ease Greece's debt crisis.
Many investors still cling to hopes that a resolution will be
reached between Greece and its international creditors--the
European Union, the ECB and the International Monetary Fund--to
avoid the risk of Greece leaving the eurozone. Investors are
concerned that if Greece departs the eurozone, it would threaten
the stability of the financial system in the bloc and generate
broad repercussions in global markets and economic growth.
Write to Min Zeng at min.zeng@wsj.com