By Min Zeng
U.S. government bonds strengthened Thursday ahead of a seven-year note auction, the last Treasury debt offering in 2016.
Strong demand for a five-year note auction sparked a price rally in the bond market on Wednesday. One supporting factor near term, say analysts, is pension funds rebalancing their portfolios following strong gains in stocks and the selloff in bonds since the U.S. election.
Pension funds typically have a targeted allocation among different asset classes, so they need to readjust the allocation ratio on either a quarterly or monthly basis.
The bond market also gets some support from month end demand, say traders. At the end of each month, newly-minted bonds replace maturing debt in some bond indices. Fund managers who closely track these indices need to replicate the changes by buying bonds.
In recent trading, the yield on the benchmark 10-year Treasury note was 2.488%, according to Tradeweb, compared with 2.51% Wednesday. Yields fall as bond prices rise.
Trading is thinner than normal due to the holiday season, which tends to exaggerate part of the price moves, say analysts.
"The usual month-end buying will need to take place in these illiquid conditions, but there also may be even more money flowing into fixed income than usual" if U.S. stocks fail to gain more traction into year-end, said Anthony Cronin, a Treasury bond trader at Société Générale.
Mr. Cronin said this is likely to bolster demand for the $28 billion sale of seven-year notes due at 1 p.m. Thursday. The bond market will be closed at 2 p.m. Friday and will remain shut next Monday to observe the New Year's holiday.
Government bond yields in the developed world have been rising after falling to their historic lows in the summer. The 10-year yield was headed for a second consecutive year of gains, up from 2.273% at the end of 2015.
The shift toward higher yields reflects rising expectations among investors of a brighter growth outlook, higher inflation and potentially a faster pace of interest-rate increases by the Federal Reserve. Selling in the bond market had intensified after the U.S. election in early November. The prospect of expansive fiscal policy from President-elect Donald Trump in the coming year has added to expectations of stronger economic growth and higher inflation.
The reflation trade -- sell Treasurys and buy stocks -- has been easing lately. The 10-year yield has pulled back after briefly brushing over 2.6% two weeks ago. The Dow Jones Industrial Average stockindex has so far failed to reach 20000, a level it has never crossed.
Some analysts say the bond market selloff has reflected optimism over fiscal stimulus. The risk, they say, is that Mr. Trump's policies may fail to live up to market expectations, which is likely to drive investors to lighten up on stocks and embrace Treasury bonds again.
"These are the things that the bond market is beginning to consider, which is why we have seen a drop in the 10--year note yield" from its recent peak, said Kevin Giddis, head of fixed income capital markets at Raymond James.
Mr. Giddis said bond yields may slide further if negative wagers on the bond market are pared back.
Hedge funds and money managers accumulated a net $66.7 billion in Treasury futures contracts betting on higher bond yields for the week that ended Dec. 20, according to data from TD Securities. The amount reached $71.87 billion two weeks earlier, the most on a weekly basis since 2008, when TD started to track the data.
Write to Min Zeng at email@example.com
(END) Dow Jones Newswires
December 29, 2016 10:40 ET (15:40 GMT)
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