By Sam Goldfarb
U.S. government bonds strengthened Tuesday after a broad gauge of U.S. economic activity fell below expectations.
The yield on the benchmark 10-year Treasury note settled at 2.356%, compared with 2.379% Monday.
Yields, which fall when bond prices rise, wavered and eventually fell after the Institute for Supply Management said its nonmanufacturing index was 57.4 in November, down from 60.1 in October and below the 59.0 reading anticipated by economists surveyed by The Wall Street Journal. A reading above 50 indicates activity is expanding across service and other industries, while a number below 50 signals contraction.
Treasurys tend to strengthen on disappointing economic data as faster economic growth can spur inflation, which chips away at the fixed returns of government bonds. Analysts also attributed the decline in yields to reports that House Republicans were delaying a vote on a short-term spending bill and a modest shift away from riskier assets, with the Dow Jones Industrial Average pulling back a day after it closed at another record.
Bond investors, meanwhile, remained cautious about the potential impact of the tax cuts being assembled in Congress.
Last week, the yield on the 10-year note climbed briefly once it looked like Senate Republicans had enough votes to pass a bill that would reduce federal revenue by about $1.4 trillion over the next 10 years.
For months, analysts have generally expected that progress on tax cuts would lead to higher bond yields, in part because legislation that expands the federal budget deficit would force the government to issue more debt, which could weigh on the prices of existing bonds. Tax cuts could also spur some economic growth and inflation, delivering another blow to Treasurys.
So far, though, there have been few signs that Treasurys are poised for a major selloff. After topping 2.4% on Thursday, the 10-year yield fell below that threshold Friday and has since remained fairly steady.
The yield, in fact, has barely changed over the past two months even as yields on shorter-term bond yields have moved steadily higher, a reflection, investors and analyst say, of expectations that inflation will stay muted while the Federal Reserve nudges up interest rates.
Tax cuts could have a relatively modest impact on long-term yields if the Treasury Department chooses to fund additional deficits mostly with short-term debt, analysts say. Any inflationary effect could also be mitigated if the Fed responds with rate increases.
A shrinking gap between short and long-term Treasury yields, known on Wall Street as a flattening yield curve, makes sense "if indeed the bill does pass and that makes the Fed more eager to raise rates next year," said Jim Vogel, interest-rates strategist at FTN Financial.
Write to Sam Goldfarb at [email protected]