Yields depressed by soft inflation, Fed patience on rates

NEW YORK: US government bond yields fell on Thursday after a measure of wage inflation came in weaker than expected, reinforcing the Federal Reserve's suggestion it may need to pause before lifting borrowing costs further.

Two-year yields, which reflect traders' expectations of interest rate hikes, fell to a nearly four-week low of 2.49 percent. The benchmark 10-year yield fell slightly further, reversing some of the yield curve steepening that happened on Wednesday following the Fed meeting. The spread between the two- and 10-year yields narrowed, last at 16.2 basis points.

The Employment Cost Index, the broadest measure of labor costs, rose 0.7 percent in the fourth quarter after an unrevised 0.8 percent rise in the third quarter, the Labor Department said on Thursday. Higher costs came as employers boosted benefits for workers, but the increase was nevertheless lower than expected.

The data continues a pattern of stubbornly low inflation in the current credit cycle.

"One of the big tenets of the Fed discussion was that if inflation stays muted... the case for hiking rates is weaker," said Brian Daingerfield, macro strategist at NatWest Markets.

The Fed held interest rates steady on Wednesday and said the central bank would be patient in raising rates further this year, pointing to rising uncertainty about the U.S. economy's outlook. The central bank described the labor market as "having continued to strengthen."

"In light of global economic and financial developments and muted inflation pressures, the committee will be patient" in determining future rate hikes, the Fed's rate-setting committee said in its policy statement.

Yields were also driven lower by a jump in weekly jobless claims, which stoked concerns about a deterioration in labor conditions and overall economic growth.

Initial claims for state unemployment benefits jumped 53,000 to a seasonally adjusted 253,000 for the week ended Jan. 26, the highest since September 2017, the Labor Department said on Thursday. The rise was also the largest since September 2017.

"As we look ahead to the average hourly earnings print tomorrow as part of the NFP, the market sees that slightly weaker-than-expected wage inflation as well as the big jump in jobless claims as reinforcing the Fed's ability to be patient that they laid out in pretty clear terms at yesterday's FOMC," said Daingerfield.

The non-farm payrolls report on Friday is expected to reflect an uptick in the unemployment rate due to the five-week federal shutdown that ended on Jan. 25.