Poor U.S. Data Pull Yields Down

Jobless-Claim Increase, Drop in Pending-Home Sales Weigh

By MIN ZENG
NEW YORK—Long-dated Treasurys rallied, sending the 10-year and 30-year yields to their lowest levels since April 2009, as weak U.S. data compounded worries about the economic outlook, boosting demand for safe-haven government bonds.

U.S. data weakness, including an unexpected increase in jobless claims and a 30% drop in pending home sales, added to anxiety about Friday's key nonfarm-payrolls report. The median forecast of economists surveyed by Dow Jones Newswires is that total U.S. payrolls fell 110,000 in June.

The market moves extend the bond market's strong finish to the second quarter, when the benchmark 10-year Treasury's yield dropped more than 0.8 percentage points. The euro zone's debt problems and weak U.S. economic reports in recent weeks have fueled anxiety in financial markets that the economic recovery, which seemed to gather pace during the first quarter, could falter in the coming months. Bond yields move inversely to prices.

Treasurys have handed investors a return of 5.86% in the year through June 30, according to data from Barclays. Over the same period, U.S. investment-grade corporate bonds returned 5.79%, high-yield, high-risk corporate bonds returned 4.51%, mortgage-backed securities returned 4.46% and municipal bonds returned 3.31%. The Dow Jones Industrial Average lost 6.27% for the first half of 2010.

"Lower yields are consistent with the headwinds the economy is facing," said Larry Dyer, head of U.S. interest rate strategy with HSBC Securities USA Inc. in New York. "The economic recovery is likely to be weaker in the second half of the year, which should be bullish for Treasurys."

At Thursday's close, the benchmark 10-year note was 7/32 higher in price to yield 2.931%. The 30-year bond was 24/32 higher to yield 3.869%.

Buying was the heaviest in the morning and at one point the 10-year note's yield, the benchmark for consumer and corporate borrowings, touched 2.878% while the 30-year bond's yield hit 3.824%.

Mr. Dyer said the 10-year yield may fall to 2.8% in the short term. HSBC, one of the 18 primary dealers that are obligated to bid in Treasury auctions, has been among the biggest Treasury bulls, consistently calling for bond yields to drop on weak economic growth.

Concerns have grown recently that the economic recovery could falter in the second half of the year when much of the extraordinary government fiscal stimulus fades. Thursday in China, data showed that the nation's manufacturing sector expanded at a slower pace for a second month, which boosted fears that the country, a major engine of the world economy, could lose traction in the months ahead.

The Federal Reserve delivered a more subdued assessment of the economy last week, raising speculation that the benchmark interest rate target will be kept at record low levels near zero for longer than many thought, as the risk of deflation increases. Inflation is the main threat to the value of long-dated Treasurys, while deflation, or a period of persistent decline in consumer prices, boosts return on nominal bonds.

With yields on short-dated Treasurys now near zero, many investors piled into long-dated securities to grab higher yields. The outperformance of long-dated Treasurys in recent weeks has narrowed their yield spreads with short-dated notes significantly. In the Treasury market, this is known as flattening of the yield curve.

The benchmark yield curve, the yield spread between the two-year note and the 10-year note, at one point touched 228.2 basis points, the flattest since May 2009. In afternoon trade, the spread was 230 basis points, down from 232.7 basis points Wednesday and 246 basis points last Friday. The gap widened to a record 292.9 basis points on Feb 18."A flattening yield curve tells us that the market expects a more modest economic recovery with lower inflation and an easier Fed," said Stephen Stanley, chief economist at Pierpont Securities LLC in Stamford, Conn

Write to Min Zeng at min.zeng@wsj.com