By Min Zeng
Prices of U.S. government bonds pulled back Tuesday, reversing the previous day's rally.
Buyers scooped up haven debt Monday, driven by the shooting of a Russian diplomat and attacks in Berlin and Zurich. But investors lightened up on bond holdings as higher stocks and crude oil prices bolstered their risk appetite.
"The safe haven bid has come out of the bond market," said Larry Milstein, managing director for government and agency trading at R.W. Pressprich & Co.
The yield on the benchmark 10-year Treasury note settled at 2.566%, near a two-year high, compared with 2.544% Monday. Yields rise as bond prices fall.
The Dow Jones Industrial Average strengthened Tuesday and traded near 20,000, a level it has never reached.
The 10-year Treasury yield closed at 2.6% Friday, the highest since September 2014 and capping the biggest six-week increase since 2009. The yield has risen by more than one percentage point from its record low set in early July.
The tide has been turning against the bond market over the past few months as data pointed to improvement in global manufacturing and upticks in inflation. The prospect of large fiscal spending, lower taxes and lighter regulation accentuated the narrative toward stronger growth, higher inflation and less generous monetary policy. Inflation chips away bonds' fixed return over time and is a big threat to long-term government bonds.
Investors and analysts say higher bond yields are a healthy sign for the economy. One popular trade after the election has been selling Treasurys to buy stocks, sending U.S. benchmark equity indices to records this month.
Stocks and corporate bonds have outpaced Treasury debt this year. The Dow has handed investors a total return of 14% this year through Monday, according to FactSet. U.S. corporate bonds issued by lower-rated firms, or junk bonds, have logged a total return of 16.6% over the same period, beating 0.42% on Treasury debt, according to Bloomberg Barclays bond indexes data. Return includes price changes and interest or dividend payments.
The 10-year Treasury yield was headed for a second consecutive year of gains, up from 2.273% at the end of 2015. Some expect the yield to rise to 3% in the coming months, a level traded in early 2014.
The Bank of Japan held its monetary stimulus steady as expected by investors earlier Tuesday. Officials upgraded their assessment on the economy for the first time since May 2015, with exports getting a lift from a weakening yen due to broad U.S. dollar strength. A softer currency makes exports more competitive in global trade. Exports play a big role in Japan's economy, the world's third largest by size.
Traders said the BOJ's brighter growth outlook drove some investors to cut holdings of haven debt.
The BOJ reiterated its commitment to anchoring the 10-year government bond yield in Japan around zero. At a time when Treasury yields are marching higher, the yield spread is moving in favor of the U.S. and boosting the appeal of the U.S. dollar. The U.S. currency reached a 14-year high Tuesday against a number of currencies including the euro and the yen.
The yield premium investors demand to hold the 10-year Treasury note relative to the 10-year Japanese government bond reached the highest since 2010 last week. A higher premium makes Treasury debt appealing on a relative basis, yet a stronger dollar has raised the cost of hedging for yen-based investors to buy Treasury debt.
Some analysts say the selloff in Treasurys reflected optimism over the economy and fiscal stimulus. Should policy details and implementation fail to meet expectations, Treasury bonds may strengthen as investors betting on higher yields may pare their wagers. In doing so, they return to the bond market to buy.
"I think we will see some stock weakness and bond strength into the end of the year," said Brian Edmonds, head of interest rates at Cantor Fitzgerald. "It has been such a big move and dramatic change in sentiment" in the bond market, he said.
Write to Min Zeng at firstname.lastname@example.org
(END) Dow Jones Newswires
December 20, 2016 16:25 ET (21:25 GMT)
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