TREASURIES-Flight to quality bond rally pushes yields lower as shutdown looms

By Davide Barbuscia

NEW YORK, Sept 30 (Reuters) - U.S. Treasury yields drifted lower on Tuesday as the prospect of an imminent U.S. government shutdown gained ground, pushing investors to seek safe assets amid political uncertainty.

Federal agencies are preparing to send thousands of workers home, as Republicans and Democrats appeared unlikely to reach an agreement that would extend funding past a midnight deadline on Tuesday. The Labor Department meanwhile has said that if there is a shutdown it would not issue its monthly unemployment report, due on Friday, which investors and the Federal Reserve scrutinize as a key barometer of economic health.

The risk of a protracted shutdown could have an impact on economic growth in the fourth quarter, analysts have said, and leave the U.S. central bank without a crucial gauge of the labor market at a time when mounting concerns over weakening jobs growth have strengthened market expectations of multiple interest rate cuts.

"The fact that we're not going to get potentially significant labor data for some time leads to a bit of a flight to quality from a Treasury standpoint," said Brendan Murphy, head of fixed income, North America, at Insight Investment.

"To me, it's more about the absence of data as opposed to any sort of big negative macro impact from the shutdown," he added.

Benchmark 10-year Treasury yields US10YT=RR were last at 4.115%, nearly three basis points lower on the day, while two-year yields US2YT=RR were nearly four bps lower at 3.594%.

Historically, government shutdowns haven’t hurt major financial assets. In fact, during the last six shutdowns the S&P 500 stocks index gained ground each time, with the most recent one in 2018-2019 coinciding with a sharp 10% rally, Deutsche Bank said in a note. Similarly for Treasuries, 10-year yields ended lower in each of the last five shutdowns, the bank said. Yields move inversely to bond prices.

The Fed lowered interest rates earlier this month and policymakers have anticipated another rate cut at the central bank's next rate-setting meeting at the end of October. Should official labor market data continue to be unavailable until then because of the shutdown, the central bank could be forced to rely more heavily on its own forecasts, making another 25 basis point rate cut in October more likely, analysts said.

"If a government shutdown removes the potential for the data to prevent further normalization, it follows intuitively that the Fed will offer another ‘risk management’ cut," BMO Capital Markets analysts said in a note on Tuesday. "After all, there are plenty of risks to the real economy by sending home a significant portion of the federal labor force," they said.

On the data front on Tuesday, the Bureau of Labor Statistics reported that the number of job openings in August was roughly unchanged month on month, while the Chicago Purchasing Managers’ Index (PMI), a gauge of regional manufacturing activity, fell to 40.6, missing forecasts.

U.S. consumer confidence declined more than expected in September amid mounting worries over the availability of jobs, the Conference Board said on Tuesday.

Rates futures traders on Tuesday were assigning a 92.5% probability of a 25 basis point rate cut in October, up from 90% on Monday.

Federal Reserve Bank of Boston President Susan Collins said on Tuesday that she’s open to more interest rate cuts amid expectations price pressures will start to wane sometime next year.