Delayed - 04/19 03:15:13 pm

U.S. Government Bonds Strengthen Ahead of France Vote

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04/21/2017 | 05:48 pm

y Min Zeng

U.S. government bonds strengthened Friday following a two-day price slide as some investors sought comfort from haven assets ahead of Sunday's presidential vote in France.

"There is a risk-off mentality going into the weekend," said Andrew Pace, vice president at Performance Trust Capital Partners LLC. "The race is neck to neck, so anything could happen."

In recent trading, the yield on the benchmark 10-year Treasury note was 2.220%, according to Tradeweb, compared with 2.239% Thursday. Yields fall as bond prices rise.

The yield on the benchmark 10-year Treasury note fell to 2.209% earlier Friday, near a five-month low it settled at earlier this week.

Another boost for bonds: U.S. crude oil futures fell below $50 again and extended a selloff over the past week. Lower energy prices reduce investors' worries over inflation, a main threat to the value of long-term government bonds. Higher inflation erodes investors' purchasing power from income earned from their bond investments.

The yield premium investors demanded to hold the 10-year Treasury note relative to the 10-year Treasury inflation-protected security, known as the 10-year break-even rate, fell to 1.84 percentage point recently Friday. That was the lowest since the Nov. 8 U.S. Election Day when it traded at 1.728 percentage point.

At its recent level, the break-even rate suggests investors' expectations of 1.84% annualized inflation rate over the next 10 years, moving below the Federal Reserve's 2% target again.

A shrinking break-even rate means investors are paring back the inflation trade which had gained momentum after Donald Trump was elected president. In doing so, investors sell TIPS and buy back Treasury debt.

The big focus for global markets near term is the first round of the French elections. If no candidate wins an outright majority, a runoff between the two candidates having the most votes will be up in early May.

Polls this week showed Emmanuel Macron, pro-European independent candidate, maintained his lead. But analysts said the results are too close to call in one of the most unpredictable races in recent history.

Right-wing candidate Marine Le Pen has advocated for France's departure from the eurozone. France is the second-largest economy in the eurozone, so investors are concerned that an exit could lead to a collapse of the monetary union.

A late surge in support for left-wing candidate Jean-Luc Melenchon, who also runs an anti-Europe platform, further complicates the outcome.

The biggest risk for investors, say traders, is that both Mr. Melenchon and Ms. Le Pen outrace mainstream candidates and enter into the second round.

"If there is any upset, we would have an ugly Monday," said Marc Bushallow, managing director of fixed income at Manning & Napier. "There would be flight to safety at least in the short term."

Demand for haven bonds is likely to retreat if Mr. Macron, the centrist, prevails in the first round.

Blake Gwinn, U.S. rates strategist at Natwest Markets, said a large selloff in Treasury debt is unlikely given the uncertainty surrounding the second-round race.

Andy Chorlton, head of U.S. multisector fixed income at Schroders, said it is "imprudent" to place big bets in financial markets either way ahead of Sunday's race.

U.S. government bond yields have sunk over the past weeks after a recent rise. The 10-year yield traded above 2.6% in mid-March.

The shift has been driven by a confluence of factors including geopolitical tensions over North Korea and Syria; political risks in Europe; a number of disappointing economic releases this month raising questions about the momentum in U.S. economic growth.

On top of that, the Trump trade -- betting on stronger growth and higher inflation driven by the prospect of large fiscal stimulus -- has been retreating. Investors are skeptical over Mr. Trump's capability to push through his fiscal stimulus agenda following the failed health-care overhaul bill last month.

Bets on higher bond yields, or shorts, have been retreating over the past weeks. Investors unwinding these bets return to the bond market as buyers, driving yields lower. That is known as short covering on Wall Street.

Some investors say bond yields are likely to rise in the longer term, driven by the improving backdrop of global economic growth and the eventual rollout of fiscal stimulus in the U.S.

Write to Min Zeng at [email protected]

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