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Bond Report: Treasury yields climb in start of 2017 as stocks, oil rise

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Bond Report: Treasury yields climb in start of 2017 as stocks, oil rise

Treasury yields on Tuesday reversed course to pare earlier gains, kicking off the first official trading session in 2017 as oil futures suffered a sharp midday about-face.

Early trading had been marked by bullish sentiment in assets considered risky, like crude-oil futures and global stocks, but a bruising pivot into the red in oil prices amid nagging concerns about adherence to an OPEC-led pact to cap production helped to sap momentum in oil which bled into broader market sentiment.

Lower oil prices CLG7, +0.54% tend to reduce inflation expectations. A pick-up in inflation can weigh on bonds by eroding the value of regular interest payments. The prospect of slightly lower oil prices, therefore, can fuel some buying in government paper, said Aaron Kohli, interest-rate strategist at BMO Capital Markets. Bond prices and yields move in the opposite direction.

Kohli also said trading in bonds is likely to be more volatile in 2017, given the sharp moves witnessed over the past two months. The 10-year Treasury note, for example, shifted from a low of 1.36% in July to a high of around 2.60% last month in the wake of Donald Trump’s U.S. presidential election victory on Nov. 8. Expectations that Trump would pursue policies resulting in a larger budget deficit while also contributing to inflation also has added to the trend of selling in Treasurys.

“After a big snowfall there is a high risk of an avalanche,” Kohli said. “If there is any sort of view that what the market has priced in is likely to be disrupted, there’s a likelihood of [sharp moves]” in bonds, he said.

On Tuesday, The yield on the benchmark 10-year Treasury note TMUBMUSD10Y, +0.75% tacked on 0.4 of a basis point to 2.450%. The yield on the two-year note TMUBMUSD02Y, +0.65% picked up 4 basis points to 1.199%.

Meanwhile, the 30-year Treasury note TMUBMUSD30Y, +0.55% known as the long bond, lost 2.3 basis points to 3.045%, extending a yield slide for the bond to four sessions.

Optimism over the start of a pact to reduce global oil output by the Organization of the Petroleum Exporting Countries and other producers stirred appetite for oil CLG7, +0.54% but that enthusiasm, which coincided with gains in European equities and the Dow Jones Industrial Average DJIA, +0.60% S&P 500 index SPX, +0.85% tapered substantially as the trading day progressed.

The bond market was closed Monday in observance of the New Year’s holiday, and holidays late in December have resulted in subdued trading activity.

Upbeat economic data in Asia and Europe, including reports that showed China’s manufacturing sector expanded more than expected and an employment reporting revealing that German jobless claims dropped by 17,000 in December, helped stoke early demand for equities and selling in bonds.

“Most of the selling in the Treasury market was due to hedging versus [European government bonds] and payers on new issue corporate supply,” wrote Tom di Galoma, managing director for Treasury trading at Seaport Global, in a Tuesday research note to clients.

On the economic front, the Institute for Supply Management said its manufacturing index climbed to a higher-than-expected 54.7% in December from 53.2%, and a read on construction spending rose 0.9% in November, above expectations and the sixth increase of the past seven months. Readings at or above 50 indicate expansion.

Some fixed-income experts said coming issuance of corporate bonds in January may weigh on Treasurys, pushing yields higher, as investors presumably prepare to rotate into corporate securities that offer richer yields than Treasurys, di Galoma told MarketWatch. “Investors are trying to set up for some decent [corporate] bond issuance,” he said.

Meanwhile, Germany’s 10-year bond TMBMKDE-10Y, +0.00% known as the bund, rose 8 basis points to 0.26%.