After breathing a sigh of relief, the Treasury market is back to the realization the Federal Reserve is most likely going to raise interest rates before year-end.
U.S. government bonds gave back gains registered following Wednesday’s Fed meeting where policy makers revised down forecasts for the pace of rate hikes beyond 2015. Data showing signs of strength in the labor market and the economy bolstered the Fed’s case to raise borrowing costs for the first time since 2006, even amid subdued inflation.
“We’ve got a dovish Fed, but the economy is picking up,” said David Keeble, the New York-based head of fixed-income strategy at Credit Agricole SA. “The next three months we’ll still get the good employment numbers coming through. If there’s an uptick on annual CPI and still improvement on the employment side, we could see a good case for the Fed to start hiking.”
Benchmark Treasury 10-year yields rose two basis points, or 0.02 percentage point, to 2.33 percent at 5 p.m. New York time, according to Bloomberg Bond Trader data. The 2.125 percent note due May 2025 fell 5/32, or $1.56 per $1,000 face amount, to 98 5/32.
Two-year yields fell two basis points to 0.63 percent. The gap between yields on Treasury two-year notes and 30-year bonds widened for a second straight day, touching 2.5 percentage points, the most in almost a month, amid concern that a slower pace of rate increases may bolster inflation risks.
Treasuries pared earlier losses as euro-area leaders called an emergency summit in Brussels on Monday to try and force a settlement on Greece after finance ministers’ efforts failed on Thursday.
“The headlines are a little concerning,” said Sean Murphy, a trader at Societe Generale SA in New York, one of the 22 primary dealers that trade with the Fed. “You are starting to see that seep into the market. There could be a situation Monday morning.”
Reports on Thursday showed U.S. jobless claims declined more than forecast last week and a survey of factory activity rose more than projected, even as the consumer price index increased less than forecast in May. An index of U.S. leading economic indicators climbed 0.7 percent in May, compared with a 0.4 percent forecast, showing growth will pick up in the second half of the year.
“The economic narrative is turning a little more positive,” said Guy LeBas, chief fixed-income strategist at Janney Montgomery Scott LLC in Philadelphia, which manages $61 billion in assets.
The Federal Open Market Committee on Wednesday reduced the median projection for the federal funds rate at the end of 2016 to 1.625 percent from 1.875 percent and cut its 2017 estimate to 2.875 percent from 3.125 percent. Officials maintained their 2015 year-end forecast at 0.625 percent, implying two quarter-point increases by Dec. 31.
The benchmark rate has been in a range of zero to 0.25 percent since December 2008.
“What the market is pricing is the dovish stance of the Fed with regard to their ability to stay at the party maybe a little longer than expected in order to achieve their inflation objective,” said Margaret Kerins, the Chicago-based head of fixed-income strategy at Bank of Montreal, one of 22 primary dealers that trade with the central bank.
The Fed affirming its its gradual approach helped boost demand at a Treasury Department auction of $7 billion in inflation-indexed bonds Thursday. Indirect bidders, an investor class that includes foreign central banks, mutual funds and pension funds, bought a record 70.9 percent of the 30-year Treasury Inflation Protected Securities.
“The Fed outlined a plan that the market may be interpreting as them getting behind the curve,” said Dan Mulholland, trader in New York at Credit Agricole CIB. “If the Fed is not going to raise rates as much as previously expected, then you could see an uptick in inflation.”
Citigroup Inc. said an improving economic outlook supported the case for raising interest rates this year, and if strong data continued September would be the most likely time. The firm had previously forecast the Fed to move in December.
The Bloomberg U.S. Treasury Bond Index handed investors a 0.9 percent loss this month through Wednesday, set for the steepest decline since February.