Treasuries Fall as New Corporate Debt Follows Japan Bond Selloff

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(Bloomberg) -- Treasuries fell as US trading returned to normal after last week’s holiday, with a surge of new corporate bond supply to begin the last month of the year.

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Yields accelerated higher during US morning — led by long-maturity tenors — after Merck & Co. slated an eight-part bond offering that includes 20-, 30- and 40-year tranches. Government bonds globally were already under pressure as Japan’s 10-year yield jumped to the highest level since 2008 on the prospect of a Bank of Japan interest-rate hike later this month.

The US 10-year yield rose as much as eight basis points to 4.09%, while shorter maturities were higher by at least four basis points. Merck’s offering and seven others — the first new investment-grade corporate bonds in a week — kick off an anticipated $40 billion month, about half of which is expected this week. Robust market conditions allowed $1.55 trillion of supply this year through November.

Meanwhile, high expectations that the Federal Reserve will cut interest rates again next week — over the objection of several policy makers who are concerned that inflation could become entrenched above the central bank’s 2% target — are strengthening the headwinds, said Jack McIntyre, a portfolio manager at Brandywine Global Investment Management.

Long-maturity yields are “driven by inflation expectations,” he said. “Cutting rates while inflation is still above target raises questions.”

Economists at Bank of America resumed forecasting a Fed rate cut next week based on delayed September employment data released Nov. 20 — which included an increase in the unemployment rate to nearly 4.5% — and New York Fed President John Williams’s subsequent endorsement of more easing amid signs of labor-market weakness.

Also Monday, a private-sector gauge of US manufacturing unexpectedly declined, and its employment component slumped, putting the brakes on the Treasury selloff.

US yields are gyrating around 4% on the prospect for rate cuts by the Fed, having dropped below that level last week after Williams said he saw room for a near-term cut.

Traders are assigning an 80% probability on the Fed lowering benchmark rates next week for a third time this year, after President Donald Trump said Sunday he had made his choice on who will next lead the central bank. That reflects the likelihood he will announce White House National Economic Council Director Kevin Hassett, who has emerged as the frontrunner to be Jerome Powell’s replacement.

Japan’s two-year borrowing costs — among the most sensitive to changes in monetary policy — climbed above 1% for the first time in 17 years. The move was fueled by BOJ Governor Kazuo Ueda talking up the prospects for a rate hike, leading money markets to lift the chance of a move on Dec. 19 to around 80%, from less than 25% one week ago.

Traders in US debt remain sensitive to BOJ policy given its control of the spigot on the flow of Japanese yen liquidity globally. Higher rates in Japan may entice domestic investors to keep more funds in local government bonds, instead of higher-yielding assets overseas such as Treasuries.

(Adds investor comment, Bank of America Fed forecast change and ISM manufacturing gauge, and updates yield levels.)

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