TREASURIES-Yields fall as retail sales disappoint expectations. BOJ maintains yield cap

(Additional data and comments from Fed officials; 20-year auction result, prices, updates prices) By Karen Brettell, NEW YORK, January 18 (Reuters) – U.S. Treasury yields fell to a 4-month low Wednesday, as data showed that U.S. Retail sales fell more than expected in Dec. and that the Bank of Japan kept its bond yield cap. This reduced concerns that U.S. bonds would be redeemed by Japanese investors. U.S. retail sales declined due to lower motor vehicle purchases as well as a wide range of goods. This resulted in consumer spending being less robust and the overall economy heading into 2023. U.S. producer prices fell more than expected in December due to lower energy and food costs. This is further evidence of falling inflation. The data is “part and parcel of this convergence from the Fed being behind to the Fed now aggressively tightening rates and … towards the end of that process,” said David Petrosinelli, senior trader with InspereX in New York. The Fed’s Wednesday report showed some encouraging signs that U.S. inflation pressures are decreasing and labor shortages are decreasing. However, economic activity is still slow as central bank actions have a negative impact on growth. After its two-day meeting, the Federal Reserve will likely raise rates by 25bps on February 1. Fed funds futures traders are now pricing for the Fed’s benchmark rate to top out at 4.87% in June, down from 4.90% before Wednesday’s data, with rates then expected to fall to 4.34% in December. The current fed funds rate is 4.33%. Traders are currently pricing in a lower Fed funds rate than Fed officials indicate. They are speculating on whether the U.S. central banks will increase or keep rates at a restrictive level if the economy is hurting. On Wednesday, James Bullard, President of the St. Louis Fed and Loretta Mester, President of the Cleveland Fed both stated that inflation must be addressed by raising rates to 5%. Petrosinelli claimed that the drop in retail sales fits with the trend where consumers spread out holiday purchases over several months. But January’s data will also be key to see if December’s fall was holiday-related, or if there are also issues with consumer spending. “That’s the real question this year – will the consumer tip over, will personal consumption tip over,” Petrosinelli said. Benchmark 10-year notes were able to drop as low as 3.372% – the lowest since Sept. The two-year yields fell to 4.072%, which is the lowest level since Oct. 4. The spread in yield between 2-year and 10-year notes was at its lowest since Oct. 4. The Bank of Japan had maintained extremely low interest rates and a bond yield limit that it was struggling to defend, causing yields to fall earlier in the day. The BOJ devised a new strategy to stop long-term rates rising too much. Analysts interpret this as an indication that Governor Haruhikokuroda will not make major policy changes during his remaining term which ends in April. The Japanese central bank could loosen its yield curve control. If this happens, Japanese yields may rise further. This would make Japanese Treasuries more attractive to foreign investors after accounting for foreign currency hedges. Japanese investors could sell U.S. government debt or make less purchase decisions. The U.S. debt limit remains a market concern. The government is expected to exceed its maximum borrowing capacity by this week. After that, it will have to resort to extraordinary measures. Although the Treasury should be able fund itself until mid-2018 or later, there is uncertainty about when it will run out of money if Congress does not increase its debt limit. Strong demand meant that the Treasury sold $12 million in 20-year bonds to $12 billion on Wednesday. They sold at a record 3.678% yield, more than two basis point below the price they traded before the auction. The bid-to cover ratio was 2.83, which is the highest since May 2020 when the bond was reintroduced. On Thursday, the Treasury will also offer $17 billion in 10-year Treasury Inflation Protected Securities (TIPS). Wednesday, January 18, 2000 GMT Price Current Net Yield Change (bps), Three-month bills 4.535 -0.021 Six month bills 3.7188 –0.146 Five-year notes 101-252/256 3.4351 and 3.4351 –0.178 Seven-year notes 101-252/256 3.4351 and 3.4351 –0.174 Ten-year bonds 104-184/256 3.6628 and 256 3.3771 ­0.148 30-year bonds 108-88/256 3.5443 0.104/US 2-year dollar swap -3.00 Spread U.25 Spread U.S.5-year dollar swap -3.00 2.25 spread U.25 Spread U.25 spread U.50-year swap -37.50 2.25 spread U.75 2.75 2.25 spread U.25 spread U.25 spread U.75 2.75 2.75 2.75 2.25 spread U.25 spread U.50 spread U.50 spread U.25 spread U.75 2.75 2.75 2.75 Spread by Lisa Shumaker.