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U.S. Government Bonds Set for 5th Straight Quarterly Gain

03/31/2015 | 02:06pm US/Eastern
   By Min Zeng 
 

U.S. Treasury bonds strengthened Tuesday, capping the fifth straight quarterly price gain that was the longest winning streak in more than a decade.

The $12.5 trillion bond market continued to gain appeal among investors who are grappling with an uncertain growth outlook overseas and subdued inflation in the developed world. Mixed economic readings in the U.S. amid a harsh winter in the East Coast has bolstered investors' expectations that the Federal Reserve would take its time in raising short-term interest rates that could potentially shrink the value of outstanding bonds.

Adding to U.S. bonds' charm: they offer much more attractive yields compared with government debt sold by Germany, Japan, the U.K. and France, driven in a large part by unconventional monetary stimulus from the European Central Bank.

"The yield differential between the U.S. and the rest of the world continues to drive foreign buyers into Treasury bonds," said Thomas Roth, executive director in the U.S. government bond trading group at Mitsubishi UFJ Securities (USA) Inc. in New York. "Domestic investors become convinced by Federal Reserve officials that these low yields are here to stay."

Bond priced rose for the last trading session of the first quarter as investors tweaked their portfolios to prepare for the end of the first quarter. Fund managers also bought bonds to match the month-end adjustments of their benchmark bond indexes.

In recent trading, the yield on the benchmark 10-year Treasury note was 1.935%, compared with 1.959% on Monday, according to Tradeweb. When bond prices rise, their yields fall.

The yield fell from 2.173% at the end of 2014. The last time the yield fell for five quarters in a row was back in March 2001.

The Treasury bond market over all has handed investors a total return--including price change and interest payments--of 1.48% this year through Monday, following 5.05% return last year, according to Barclays PLC.

But lower yields mean lower income. With yields near historical lows, analysts have warned that if sentiment on the bond market sours, bondholders are vulnerable to capital losses.

A sign of investors' hunger for income, some riskier bonds outperformed Treasury debt. Bonds sold by lower-rated U.S. companies posted a return of about 2.5% this year through Monday, according to Barclays. U.S. investment-grade corporate bonds returned 2.1%. Treasury inflation-protected securities returned 1.2% and municipal bonds returned 1%.

The mixed growth outlook has cast doubt over whether the Fed could start raising short-term interest rates this June. Many investors still see a very low probability for the Fed to raise rates this summer.

The federal-funds futures, used by investors and traders to place bets on central-bank policy, showed Tuesday that the market sees a 6% likelihood of a rate increase in June, unchanged from Monday, according to data from CME Group.

Fed Chairwoman Janet Yellen said Friday the timing hinges on how the economy performs in the months ahead. She said the tightening cycle this time would be gradual. The Fed last raised interest rates in 2006. It has kept the fed-funds target rate near zero since December 2008.

The nonfarm payrolls report for March due this Friday is the key datapoint to shape up investors' expectations on the timing of the first interest-rate increase by the Fed in nearly a decade. The Fed's next policy meeting is set for April 28-29.

Economists polled by The Wall Street Journal expect the U.S. economy to have added 248,000 new jobs in March, after a net gain of 295,000 in February. The unemployment rate is expected to have stayed unchanged at 5.5%.

"With the Fed getting closer to policy tightening, the bond market is walking on pretty thin ice," said Mark Dowding, co-head of investment-grade debt at BlueBay Asset Management, which manages $62.8 billion of assets. "As long as the economy rebounds from its first-quarter dip, yields are likely to be materially higher in the next few months."

Larry Milstein, head of government and agency trading at R.W. Pressprich & Co. in New York, said he doesn't anticipate "a major move higher in yields" because higher U.S. bond yields remain attractive to foreign buyers.

Bond strategists at Goldman Sachs Group Inc. now expect the 10-year Treasury yield to end this year at 2.5%, down from the 3% the bank predicted at the start of the year.

Write to Min Zeng at min.zeng@wsj.com

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