By Sam Goldfarb

A rally in U.S. government bonds picked up momentum Thursday as investors moved out of trades that have been popular since the November election.

Bond prices climbed in the morning as stocks and the dollar weakened, suggesting investors were becoming less confident in their belief that economic growth and inflation are poised to increase due to more expansive fiscal policies under a Donald Trump administration.

The yield on the benchmark 10-year Treasury note settled at 2.370%, its lowest close since Dec. 7, compared with 2.452% Wednesday. The yield dropped to 2.352% at around noon before rebounding as stocks also retraced some of their losses.

Yields fall as bond prices rise.

Minutes from the Federal Reserve's December meeting, released Wednesday, presented a mixed picture of the economy. However, investors and analysts appeared to focus on the more negative aspects of the discussion, including uncertainty over the impact of Mr. Trump's fiscal policies and concern that the strengthening dollar could make it harder for inflation to reach the Fed's 2% target.

After plunging to record lows over the summer, bond yields rose sharply toward the end of last year, reflecting better economic data, signs of rising inflation and expectations that Mr. Trump and a Republican-controlled Congress will increase the budget deficit by cutting taxes and boosting spending on defense and infrastructure.

A more expansive fiscal policy could diminish the value of outstanding government debt by adding to the supply of bonds. It could also spur growth and inflation, which would erode the fixedreturns of bonds and possibly lead the Federal Reserve to quicken its pace of interest-rate increases.

Some investors, though, have questioned whether the postelection bond selloff was entirely justified. They note the economy still faces long-term challenges, which may be difficult to overcome with a change in fiscal policy that itself is uncertain.

After rising in the aftermath of the election, bond yields began to decline in the final weeks of December. Before the turnaround, the 10-year yield had closed at 2.600% on Dec. 16, up from 1.867% on Election Day.

"You're seeing a lot of assets that had done well last year being sold," said Aaron Kohli, interest-rate strategist at BMO Capital Markets. "If people are recalibrating their original expectations for what Trump and the new Congress can deliver to something a little more realistic that should translate into slightly lower yields."

Further unsettling traders Thursday was a newwave of liquidity tightening by China's central bank, which sent the yuan to its highest level against the dollar since November.

Investors also reacted to a soft report on private payrolls, which created some pessimism ahead of Friday's closely-watched employment report from the Labor Department.

Despite widespread hopes that economic growth will improve under the new president, investors remain confident that the Fed will raise rates at a slow pace this year, suggesting they don't expect a major jump in inflation.

The Fed raised short-term interest rates in December for the second time in a decade and projected three rate increases this year. Still, interest-rate-derivative markets show investors believe the Fed will only raise rates twice this year, beginning at the end of spring.

Fed funds futures, a popular derivative market for investors and traders to place bets on the Fed's rate-policy outlook, showed Thursday a 64% probability of the Fed raising interest rates by its June meeting, according to CME Group . The odds of the Fed raising rates at least three times, or three quarters of a percentage point, by December were 33%, down from 40% Wednesday.

Higher interest rates from the Fed tend to shrink the value of outstanding bonds, especially those with shorter maturities.

COUPON ISSUE Price CHANGE YIELD CHANGE

1% 2-year 99 23/32 up 3/32 1.154% -5.6BPS

1 3/8% 3-year 99 28/32 up 6/32 1.424% -6.8BPS

2% 5-year 98 21/32 up 13/32 1.865% -8.2BPS

2 1/4% 7-year 100 16/32 up 19/32 2.175% -9.0BPS

2% 10-year 96 25/32 up 23/32 2.370% -8.2BPS

2 7/8% 30-year 98 7/32 up 1 18/32 2.965% -8.0BPS

2-10-Yr Yield Spread: +121.6BPS Vs + 124.2BPS

Source: Tradeweb/WSJ Market Data Group

(END) Dow Jones Newswires

January 05, 2017 16:05 ET (21:05 GMT)

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