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Treasury Market Rally Stalls on Final Day of Winning Quarter

(Bloomberg) — A rally in US Treasuries lost momentum on the final trading day of June, with yields extending their climb in the last hour of trading when bond indexes rebalanced.

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Longer-maturity yields rose at least 10 basis points on the day, capping a week that was marked by accelerating inflation overseas and currency-market fireworks. The calendar-driven spike extended a rebound from the session lows seen after an ebb in the Federal Reserve’s favored inflation gauge.

“It’s been a choppy environment,” said Gregory Faranello, head of US rates trading and strategy for AmeriVet Securities. “Although we had some decent moves this month, no one is chasing the yields lower. Data has been weaker, but it’s not totally falling apart.”

Ten-year yields, which earlier slipped as much as three basis points, climbed as much as 12 basis points, peaking in the late US trading session. Treasury futures volumes surged to their highest levels of the week during the minutes around 4 p.m., when bond indexes maintained by Bloomberg Indices, controlled by the parent of Bloomberg News, were rebalanced.

Month-end index rebalancing — in which bonds sold during the month are added and some older ones drop out — drives trading by index funds and other passive investors that can move the market in unpredictable ways.

Friday’s selloff cut short what was set to be the biggest monthly bond rally of the year. Ten-year yields are still down 12 basis points in June, after an 18-basis-point drop in May.

Over the past week, data had shown a pickup of inflation in Australia and Canada, heaping pressure onto domestic government bond markets. A resilient dollar has also wreaked havoc across global foreign-exchange rates, with the Bloomberg Dollar Spot Index climbing to a fresh year-to-date high this week. That dragged the yen to its weakest since 1986, raising the risk that Japanese authorities will intervene to support the currency.

Those developments arrested a two-month rally for Treasuries fueled by signs of cooling in inflation and the labor market. A report on Friday showed inflation as measured by the price index for personal consumption expenditures, the so-called PCE price index, was unchanged in May for the first time this year.

Still, the 10-year Treasury yield has been struggling to break below 4.2% since mid-June, with Fed officials reiterating they need to gain more confidence in the inflation outlook before cutting interest rates.

Richmond Fed President Thomas Barkin said on Friday the inflation battle still hasn’t been won, and the US economy is likely to remain resilient as long as unemployment remains low and asset valuations high. On CNBC, San Francisco Fed President Mary Daly said the latest inflation data indicates monetary policy is working, but that it’s too early to tell when it will be appropriate to lower borrowing costs.

Bond investors have been on a roller-coaster ride in the first half of the year. They kicked off 2024 pricing in about six quarter-point rate cuts for the year, but have steadily pulled back on those expectations.

Swaps traders expect around 45 basis points worth of rate cuts for the year, with a quarter-point reduction fully priced in by November. Fed officials recently dialed back their projections for rate cuts this year to just one.

Some traders in the options market linked to the Secured Overnight Financing Rate, though, on Thursday started to target two rate reductions this year before the December policy meeting and a more dovish policy outlook versus broader market pricing.

Next week, bond traders will turn to June employment data to gauge the Fed’s policy path ahead. Economists expect job growth to slow and a steady unemployment rate at 4%. Investors are also wrestling with uncertainty around the US presidential election.

Jason Williams, a strategist at Citigroup, said he’s neutral on the bond market, at least until the labor market shows more cracks.

“The data is softening, but it feels a little early to me for there to be enough data” to warrant 10-year yields below 4%, he said.

(Adds declines into month-end index rebalancing and updates yield levels. An earlier version corrected reference to year.)

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