US Treasury futures rise on flight to quality, cautious Fed speak

By Davide Barbuscia

NEW YORK (Reuters) – U.S. Treasury futures rose on Monday on expectations that investors will buy bonds as a safe haven during the conflict in the Middle East and as Federal Reserve officials made dovish comments.

The U.S. Treasury cash market was closed for a public holiday, but Treasury futures – contracts for the purchase and sale of bonds for future delivery – rose. Prices of 10-year Treasury futures went up to their highest in a week.

The implied yield on the benchmark 10-year Treasury in futures markets was at 4.62%. Yields in the cash market stood at 4.78% on Friday.

Fed funds futures indicated that expectations of a November interest-rate increase fell to 12% on Monday, from 27% on Friday, CME Group data showed. The probability of a December hike fell to 24% from 38%.

A deepening conflict between Israel and the Palestinian Islamist group Hamas roiled global markets on Monday and pushed investors toward safe-haven assets, while crude prices surged as investors worried a wider war could hit Middle East oil supply.

Treasuries are among the most popular destinations for nervous investors and it would not be surprising to see them bid up on Tuesday due to Mideast turmoil, said Zhiwei Ren, a portfolio manager at Penn Mutual Asset Management.

He cautioned poor liquidity on Monday made it hard to predict the extent of any potential rally.

“Today’s market might just be an over-reaction because not many people are trading … when the market opens tomorrow we’ll get a better feel,” he said.

Meanwhile, top ranking Federal Reserve officials indicated that rising yields on long-term U.S. Treasury bonds could steer the Fed from further rate increases.

Fed Vice Chair Philip Jefferson said the central bank could “proceed carefully” in deciding whether any further increases are warranted. Dallas Fed President Lorie Logan said the higher returns being demanded by investors to hold long-term U.S. government debt could offset the need for higher rates.

Treasury yields – which move inversely to bond prices – have recently surged to their highest levels in more than a decade-and-a-half on concern the Fed would keep rates higher far longer than previously expected, in addition to worries over rising U.S. debt levels. The climb in yields has battered stocks, with the S&P 500 off some 7% from its late-July high.

In addition to reducing expectations of further hikes, traders on Monday also increased bets that the Fed may start cutting rates as soon as May next year. The probability of a 25 basis points reduction in May stood at 38% on Monday, compared to 27% at the end of last week.

“To some degree there’s a recognition that financial conditions have tightened without the Fed having to take that extra step (of another rate hike),” said Michael Reynolds, vice president of investment strategy at Glenmede.

He said the dovish outlook may have helped boost stocks. The S&P 500 reversed losses to close up 0.6% on Monday.

“We don’t think (rate increases are) off the table, but incrementally it seems a little less likely in this environment,” he said.

(Reporting by Davide Barbuscia; Editing by Ira Iosebashvili and David Gregorio)