October 8, 2019 / 2:35 PM / 11 days ago

TREASURIES-Yields fall on trade war escalation, low U.S. inflation

NEW YORK, Oct 8 (Reuters) - U.S. Treasury yields fell Tuesday morning as expectations of a Federal Reserve interest rate cut in October rose following big declines in producer price index data and an intensification of trade tensions with China.

Ahead of trade negotiations in Washington this week, the U.S. government widened its trade blacklist to include some of China’s top artificial intelligence startups. Beijing was angered by the decision, which bars 20 Chinese public security bureaus and eight companies from buying components from U.S. companies without U.S. government approval - a potentially crippling move.

The two-year yield, which is a proxy for investor expectations of changes in interest-rate policy, was last down 2.8 basis points to 1.436%. The benchmark 10-year yield was last 3.1 basis points lower to 1.522%, falling near the psychologically significant 1.5% level, which has not been breached since early September.

Treasuries offer a safe, high-quality investment in times of market turmoil, and have therefore risen in price - and fallen in yield - in response to increased trade tension.

“The Treasury market is trading higher this morning mainly because the markets seem to be reactive to only trade-related news, especially if China is involved. Just as the Chinese delegation comes to town, each country seems to be doing things to add pressure to the negotiations,” said Kevin Giddis, chief fixed income strategist at Raymond James.

Expectations of a 25 basis point interest-rate cut by the Fed at its meeting later in October rose on Tuesday to 81.8% from 74.8% a day prior, according to CME Group’s FedWatch tool. Fed Chair Jerome Powell will speak later Tuesday.

Monetary easing forecasts were also elevated because U.S. producer prices unexpectedly fell in September, leading to the smallest annual increase in nearly three years. The Fed cut rates in September after reducing borrowing costs in July for the first time since 2008, to keep the longest economic expansion on record, now in its 11th year, on track.

“Both the headline and core measures of the Final Demand Index are stunningly weak,” said Thomas Simons, senior money market economist at Jefferies. But, he cautioned, Tuesday’s data does not necessarily indicate that consumer price index data to be released on Thursday will also be weak.

“We think it would be totally inappropriate to draw firm conclusions for the CPI data from the PPI. The indexes are calculated using totally different methodologies and while they are both nominally “inflation indexes,” they measure different things.”

Reporting by Kate Duguid; Editing by Steve Orlofsky

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