US bond prices post small gains

Treasury bonds traders
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U.S. Treasury debt prices rose in light volume on Friday, aided by a lack of new supply and by the stock market's struggle to advance from near record-high levels.

Traders cited investors buying a high percentage of this week's $72 billion coupon-bearing supply and positive technical signals as catalysts for benchmark yields to retrace further from their recent near two-year peak of 2.75 percent.

A late summer mini-rally could push the 10-year yield below 2.50 percent over the next couple of weeks, traders said, and a pullback in U.S. stock prices could help spur such a move if it renewed interest in safe-haven U.S. government debt. U.S. stocks fell on Friday, leaving them with their biggest weekly decline since June.

"Treasurys have corrected a big part of (the decline in yields) driven by the Fed's quantitative easing," said Brian Hess, associate portfolio manager and senior research analyst at Philadelphia-based Brandywine Global with $45 billion in assets under management.

With the economy "gaining traction, the Fed doesn't have to do as much quantitative easing and Treasurys are not as overvalued as they were earlier in the year," he said, adding that he was "neutral toward Treasurys" at these levels.

"At 3.5 percent on 10-year yields and 4.25 percent on 30s, we'd be much more interested in buying them, assuming the macro economic backdrop was broadly similar," he said.

Hess said he expected the Fed to trim its bond purchases in the fourth quarter of the year. "If we get a couple more (subdued) jobs reports like July's, then tapering could come closer to yearend," he said. Conversely, if the economic data strengthens in the next six weeks, "that could bring the tapering forward to September."

Much of the recent economic data, with the notable exception of disappointing July payroll growth, has hinted at steady, if subdued, U.S. economic growth in the second half of the year.

Economists marked up their view on second-quarter gross domestic product growth after data showed the U.S. trade deficit shrank in June to its smallest size in more than 3-1/2 years. Many now think second quarter GDP will be revised to above 2.0 percent later this month from the modest 1.7 percent annualized rate originally reported. Still, the upward revisions to GDP estimates were tempered by a surprise drop in wholesale inventories in June.

(Read more: GDP growth questioned as data misses)

Matthew Duch, portfolio manager at Calvert Investments in Bethesda, Maryland, said after a "pretty tough" May-June period, the bond market had established a new range, "based on the expectation of Fed tapering."

But Duch said it was unclear how bonds would react to cuts in the Fed's bond purchases when they actually materialize. When the first and second phases of quantitative easing ended, bond yields went lower because those moves were viewed as less inflationary and, thus, good for bonds, he observed. "Bond yields could come down if growth just muddles along," Duch said. But if tapering occurs in conjunction with strong GDP growth, it would likely be seen as bearish for bonds, he said.

As for the timing of "tapering," all the rhetoric coming from the regional Fed bank presidents points to the fall, Duch said.

"They're prepping the markets for this and the tapering is needed so that investors rebalance and recognize they might not have the Fed 'put'," he said. "We'll have a healthier two-way flow rather than just all buyers or all sellers."

In below-average summer trading volume, the 10-year Treasury note rose 3/32 in price, its yield easing to 2.58 percent from 2.595 percent late on Thursday and from 2.644 percent a week ago.

The 30-year yield, at 3.635 percent, was down from 3.676 percent on Thursday and 3.731 percent a week ago. Worry that bond prices could fall further and yields could rise from these levels motivated more investors to redeem bond fund shares. A record $3.27 billion exited U.S.-based Treasurys funds in the latest week, data from Thomson Reuters' Lipper service showed on Thursday.

(Read more: Are you not entertained? Pimco vows 'bond war' win)

—By Reuters

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