Bond Market Now Divided Over Whether Fed Will Even Lift in March

Central Banks and the Global Threat of Deflation
  • Probability of Fed waiting until 2016 increases to about 70%
  • Ten-year note yield marks lowest closing level since April

First Treasuries traders were banking on September for the Federal Reserve to raise interest rates. Then they turned their focus to December. Now even March is looking like a toss-up.

The drumbeat of weaker-than-forecast global economic data continued Wednesday as September U.S. retail sales fell short of analysts’ expectations. The report came after Fed Governor Daniel Tarullo, who votes on rate decisions, said Tuesday that he doesn’t currently favor an increase in 2015, even though Chair Janet Yellen has said a move would probably be warranted. The Treasury sold four-week bills at a rate of zero percent Wednesday, reflecting investors’ demand for a haven.

Traders’ bets that the Fed will lift its benchmark by year-end have dropped to less than a 30 percent chance, and aren’t much higher for January. For March, the probability has tumbled to about 49 percent, from 66 percent at the start of the month. The calculation is based on the assumption that the effective fed funds rate will average 0.375 percent after the first increase.

The economic figures "will certainly be highly influential for the Fed, particularly in its course of policy action and whether they are able to hike this year or not, and so far this is a fairly strong vote in the negative camp," said Christopher Sullivan, who oversees $2.4 billion as chief investment officer at United Nations Federal Credit Union in New York.

The benchmark 10-year note yield fell seven basis points, or 0.07 percentage point, to 1.97 percent as of 5 p.m. in New York, the lowest on a closing basis since April 27, according to Bloomberg Bond Trader data. The 2 percent security due in August 2025 rose 5/8, or $6.25 per $1,000 face value, to 100 7/32. The yield’s dip below 2 percent leaves it close to levels seen in the wake of the August market turmoil fueled by China’s surprise yuan devaluation.

Market Signal

Last month, the Fed forecast the tightening cycle will end with the funds rate at 3.5 percent. Yet the swaps market is pricing in a terminal funds rate of 1.32 percent in three years, according to overnight index swaps data.

The 0.1 percent gain in retail sales followed little change in the prior month that was weaker than previously reported, Commerce Department figures showed. The median forecast of 82 economists surveyed by Bloomberg called for a 0.2 percent advance.

In their September meeting, Fed officials kept their benchmark near zero, where it’s been since 2008, to assess how slowing growth abroad is affecting the U.S. Projections prepared for the gathering showed that 13 of 17 of the central bankers saw a rate boost as appropriate this year.

Bets Fade

Bets on a 2015 Fed liftoff have faded since an Oct. 2 U.S. report showing the nation’s job market was weaker in September than most economists anticipated. This week, a decline in Chinese imports underscored the headwinds to global growth.

While some Fed officials say they see a rate boost this year as appropriate, “the market obviously senses something else, whether it’s the global story impacting the domestic story or something else, which makes them challenge the Fed,” said David Ader, head of U.S. government bond strategy at CRT Capital Group LLC in Stamford, Connecticut.

Investors are the most bullish on Treasuries in 18 months, according to the latest JPMorgan Treasury Client Survey.

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