Treasuries rally on concerns over subprime lending

Government bonds rose on Friday, rounding off a mixed, range-bound week in which there was little market-moving news except for Japan raising interest rates, though only to 0.5 per cent.

US Treasury prices rallied, but yields remained trapped in a long-standing range with investors waiting for a catalyst to shift rates in a decisive manner.

Traders said Friday’s recovery was mainly related to month-end demand from money managers and concerns over the subprime mortgage market.

Problems in the subprime market remain contained to that sector but some traders believe broader weakness in housing will ultimately damp down growth in the economy and sanction rate cuts later this year.

“We think that the drag from housing will ultimately translate into weaker US employment conditions, spurring rate cuts that will begin in May,” said William O’Donnell, fixed-income strategist at UBS. Interest rate futures price in a small chance of a rate cut by the middle of this year.

The yield curve for Japanese government bonds continued to flatten on Friday.

The yield on the two-year rose 2 basis points to 0.840 per cent but yields on ultra-long bonds fell, responding to steady demand from investors wanting to match long-dated liabilities with long-dated assets. The yield on the 30-year declined 1.5bp to 2.325 per cent.

UK gilts and European government bonds rallied in tandem on Friday to end the week flat or better.

Both were driven primarily by a surprisingly weak German Ifo index of business confidence, but were also helped later on by the pick-up in US Treasuries.

Like US issues, European bonds have been confined to a tight range.

“The market has been looking for a trigger to help them break out of this range but this hasn’t happened,” said José García-Zárate, analyst at 4Cast.

The yield on the 10-year gilt ended the week up 0.3bp, and the yield on the 10-year bund was almost 2bp lower.