NEW YORK, July 12 (Reuters) - A sharp decline in U.S. Treasury yields after cooling inflation data has boosted a measure of total returns for government bonds to positive territory for the first time in months, although many in the market fear fiscal worries may dampen enthusiasm over the near-term prospect for interest rate cuts.
Year-to-date total returns, which include bond payouts and price fluctuations, turned to 0.324% on Thursday, according to the ICE BofA US Treasury Index on Friday. Returns had been negative since early February.
Data on Thursday showed U.S. consumer prices fell for the first time in four years in June, making it more likely the U.S. central bank will cut interest rates in September. That spurred a sharp decline in Treasury yields, with benchmark 10-year yields closing at 4.19% on Thursday, their lowest since March.
"In the short term, we should have positive returns for Treasuries because the data is slowing down ... naturally Treasuries should do well in this environment," said Zhiwei Ren, portfolio manager at Penn Mutual Asset Management.
Treasury yields, which move inversely to prices, are still higher this year, with benchmark 10-year yields still about 35 basis points above where they stood at the end of last year. Bond losses followed high inflation readings in the first quarter that indicated price pressures were unlikely to abate as quickly as the market, and the Federal Reserve, had projected.
But over recent weeks, data has implied slowing economic activity, boosting market expectations that the central bank will shift to a less restrictive monetary stance.
Thursday's inflation data was "pivotal" according to Lindsay Rosner, head of multi-sector investing at Goldman Sachs Asset Management, as it helps the Fed gain confidence inflation is moving in the right direction. John Kerschner, head of U.S. securitized products at Janus Henderson Investors, said the data gave the Fed "the all clear sign to start lowering rates later this year".
Some in the market, however, struck a more cautious tone.
Vanguard said it continues to forecast no rate cuts this year. "The Fed is looking for a reason to cut, but it also can't ignore that cutting too soon - especially with the labor market and wage growth still strong - could risk reigniting inflation," said Josh Hirt, a senior economist.
Others are skeptical about the outlook for Treasuries for the rest of the year because of uncertainty around the U.S. presidential elections.
Increased chances of a Republican sweep could be seen as inflationary, said Ren at Penn Mutual. "That could drive prices down later in the year, short-term market is bullish but in the medium term it might be bearish again, so we are not taking a big bet at this point" he said.
Barclays analysts said in a note on Thursday higher chances of a Trump victory "should be accompanied by a non-trivial risk of inflationary policies being put in place from next year onward, arguing for less easing." They recommended shorting five-year Treasuries.
Annual total returns for Treasuries turned positive late last year as bonds rallied because of expectations of rate cuts due to a sharp deceleration in inflation.
Total returns went from minus 13% in 2022 - the worst annual performance to date for Treasuries - to nearly plus 4% in 2023, according to the ICE BofA US Treasury Index. (Reporting by Davide Barbuscia Editing by Christina Fincher; Barbara Lewis and David Evans)
