US Bond Prices Edge Lower as Rally Pauses

Junk or Jewels? The Lowdown on High-Yield Bonds
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U.S. government debt prices were lower on Monday as investors booked profits after last week's rally and dealers prepared for this week's auctions of $66 billion in longer-dated Treasury debt.

Benchmark yields hovered near the lows for the year set on Friday in the wake of very disappointing data on the U.S. jobs market and the Bank of Japan's plan to buy $1.4 trillion in assets. The two factors forced traders to downgrade their outlook on the U.S. economy and revise up their view on foreign appetite for dollar-denominated debt.

"The market is taking a bit of a breather and digesting the two big surprises from last week,'' said Michael Brandes, global head of fixed income strategy at Citi Private Bank in New York.

Benchmark U.S. 10-year Treasurys last traded down 5/32 in price for a yield of 1.732 percent. The 30-year bond was last 19/32 lower in price to yield 2.904 percent.

Despite the modest backup, Treasury yields might revisit the historical lows seen last summer if the U.S. economy exhibits a mid-year slowdown similar to the previous two years.

"We should see good buying on any backup (rise) in yields," said Michael Cullinane, head of U.S. Treasurys trading at D.A. Davidson & Co. in St. Petersburg, Florida.

The 10-year yield broke below its 200-day moving average on Friday, the first time since December. The breach of this technical resistance level suggested the likelihood that the 10-yield may test the historic intraday low of 1.3810 percent set in July.

On below-average volume, the 30-year bond was down 3/32 at 104-27/32, yielding 2.882 percent, up 0.4 basis point from Friday's close. The 30-year yield was about 4 basis points above its lowest level of the year set on Friday, when the 30-year yield posted its biggest single-day drop since late May.

U.S. Treasurys lagged Japanese government debt as the 10-year yield premium over the Japanese counterpart grew to 1.195 percentage points from 1.179 points on Friday.

The Bank of Japan's planned stimulus has stoked bets on a spike in demand for higher-yielding U.S. Treasurys from domestic insurers and pension funds as the announced asset purchase plan knocked Japanese yields to record lows and the yen to multi-year troughs against the dollar and the euro.

Like the U.S. Federal Reserve's bond purchase programs, the BoJ's quantitative monetary policy aims to lower long-term borrowing costs and stimulate spending and investments.

(Read More: Forever Fed: Jobs Blues Sets Up Eternal Easing)

Moreover, the depreciation of its currency should help Japanese exporters by making their goods cheaper abroad.

Another source of support for U.S. bond prices has been the Fed's bond purchases. On Monday, the U.S. central bank bought $1.399 billion in Treasury inflation-protected securities, which was the latest part of its bond purchase program intended to lower long-term borrowing costs and to lower unemployment.

In light of the market rally, which made Treasurys more expensive, analysts said some investors might bid less aggressively for this week's government debt supply.

The U.S. Treasury Department will sell $32 billion in three-year debt on Tuesday; $21 billion in 10-year notes on Wednesday; and $13 billion in 30-year bonds on Thursday.

Still, overall demand for the latest Treasurys supply should be solid as traders brace for a possible pickup in Japanese appetite for Treasurys, according to Citi's Brandes.

"I expect fairly strong auctions this week even after we had a substantial rally," Brandes said. "We could see some flows out of large Japanese institutions."

In "when-issued" activity, traders expected the upcoming three-year note issue to yield 0.3380 percent midday Monday, which was on track as the lowest yield at a three-month note auction in four months.