* Benchmark yields set for first weekly drop since April
* TIPS recover after U.S. producer prices rise in May
* Futures suggest traders pricing out Fed hike before 2014
* Data point to sluggish U.S. growth, mild inflation
By Richard Leong
NEW YORK, June 14 U.S. government debt prices
rose on Friday as traders bought bonds on the view the Federal
Reserve would stick to its near-zero interest rate policy for a
protracted period to help the economy even if it reduces its
bond purchases this year.
That view emerged after a Wall Street Journal report on
Thursday which said an adjustment in the Fed's bond-buying
program did not mean that the U.S. central bank would end the
purchases "all at once" or that the Fed was "anywhere near
raising short-term interest rates."
The article allayed the market's worst fears that the U.S.
central bank was preparing for a quick exit from the
quantitative easing policy it adopted more than four years ago.
The Fed has been buying bonds with the goal of lowering
long-term interest rates.
Those worries grew out of comments from Fed Chairman Ben
Bernanke at a testimony before a congressional panel on May 22,
when he said a decision on whether to reduce its current $85
billion monthly bond purchases could come at one of the central
bank's "next few meetings" if the economy proves it's on a
steady growth path.
"It's important for the Fed to reposition the market to
think that a rate increase is at least two years away," said
Justin Hoogendoorn, fixed income strategist at BMO Capital
Markets in Chicago.
Short-term interest rates futures jumped in the wake of the
Wall Street Journal report, suggesting traders dialed back bets
that the Fed might raise rates next year.
The Dec 2014 federal funds contract implied traders
anticipated a 42 percent chance of a Fed rate hike at the end of
next year, down from 47 percent on Thursday, according to CME
Group's FedWatch, which computes traders' expectations on the
fed funds rate that the Fed influences through monetary policy.
A month ago, that contract implied a 26 percent of a rate
increase at the Fed's Dec 2014 policy meeting.
Fed policy-makers, who will meet Tuesday and Wednesday,
might offer more clues about their collective view on the
current third round of bond purchases, known as QE3.
"That (Wall Street Journal) article put things back into
perspective. Next week, the market is looking for clues about
possible timing on a tapering," said Sean Simko, head of fixed
income management at SEI Investments Co. in Oaks, Pennsylvania.
Reduced anxiety about the Fed raising short-term rates,
together with, on balance, weaker-than-expected data on
industrial output and consumer sentiment, spurred buying in
Treasuries, sending benchmark yields to their lowest levels in a
The yield on 10-year Treasury notes was on track for its
first weekly decline since late April. This would snap the
longest weekly losing streak for the 10-year note since late
March to early May 2009 when its yield rose for seven straight
weeks, according to Reuters data.
The 10-year note last traded 11/32 higher in
price with a yield of 2.108 percent, down 4.1 basis points from
late on Thursday.
The 30-year bond rose 21/32 to yield 3.279
percent, 3.4 basis points lower than Thursday's close.
Treasury yields rose to 14-month highs earlier this week on
fears about the Fed buying fewer bonds.
The bond market stabilized from its recent sell-off as data
showed the U.S. economy, while growing, has been unable to gain
traction due to high unemployment. Federal budget cuts and
expiration of a payroll tax holiday have added to the drag on
growth this year.
"The Fed is trying to lay down a road map, but the market
has over-reacted," Simko said.
Data on Friday showed industrial output was unchanged in
May, falling short of the 0.2 percent rise forecast by
economists, while the Thomson Reuters and University of Michigan
said their index on U.S. consumer sentiment unexpectedly fell
from a near six-year high in early June.
While these latest reports signaled a U.S. economy
struggling to gather steam, a government report showed domestic
price growth, while weak, was not at the precipice of deflation,
a downward price spiral that had crippled Japan for a decade.
The U.S. producer price index grew 0.5 percent last month,
more than the 0.1 percent gain projected by analysts.
The inflation news helped bolster Treasury Inflation
Protected Securities, which had been pummeled since early April
by heavy selling on falling inflation expectations and fears
over reduced bond purchases from the Fed.
The yield on 10-year TIPS briefly fell below
zero percent before returning into positive territory. On
Monday, the 10-year TIPS yield traded above zero for the first
time since January 2012, according to Reuters data.
Separately, at 11:00 a.m. (1500 GMT), the Fed bought $1.46
billion in Treasuries whose maturities range from February 2036
through May 2043.