January 6, 2020 / 9:05 PM / 17 days ago

TREASURIES-Bonds sell off as oil holds onto recent price gains

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By Kate Duguid

NEW YORK, Jan 6 (Reuters) - U.S. Treasury bonds sold off on Monday, lifting yields as the price of oil remained elevated on heightened tensions between the United States and Iran.

The benchmark 10-year yield had its first positive day since Dec. 31. From its close on Thursday to its open on Monday, the 10-year yield fell 6% as investors sought out safe-haven assets after U.S. President Donald Trump authorized on Jan. 2 an overnight air strike in Baghdad which killed Qassem Soleimani, Tehran’s most prominent military commander.

But by Monday afternoon, yields across maturities were higher, with the 10-year last up 1.8 basis points to trade at 1.809%. Some analysts suggested the reversal could be explained by the sustained rally in oil prices.

Brent crude futures rose as high as $70.74 a barrel on Monday before settling around $68.35 in late afternoon trade. U.S. West Texas Intermediate crude was down modestly to $62.79 a barrel after hitting $64.72, its highest since April 2019.

“The classic response in markets to increased tensions in the Middle East is that oil prices rise,” said Tom Simons, money market economist at Jefferies.

Traditionally, higher oil prices have been accompanied by higher inflation, and “higher inflation should lead to higher yields,” he said. “Bonds should sell off.”

Although the United States is now less reliant on sources in the Middle East for oil, the sell-off in this instance may still make sense.

“Given the strength of the economy and the potential for the manufacturing sector to pick up a little bit here - given the trade deal and the low starting point - maybe there are good reasons to think that oil could hold the bid here for a little bit longer this time,” said Simons.

“If anything it may make the Fed think about raising rates at some point, theoretically.”

The two-year yield, which reflects market expectations of Federal Reserve interest rate policy, was up 1.8 basis points to 1.543%.

Although the Fed is not seen as likely to move interest rates in the near-term and has expressed a high tolerance for inflation, “on the margin it does say that, at least directionally, that’s what you’re looking at.”

Beyond geopolitical tension, the other primary theme this week is new bond supply. The Treasury Department on Monday auctioned off $78 billion in new 13- and 26-week bills to strong demand. On Tuesday, it will sell $38 billion of new three-year notes; on Wednesday, $24 billion of 10-year notes; and on Thursday, $16 billion of 30-year bonds. (Reporting by Kate Duguid; Editing by Andrea Ricci)

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