Treasuries' Muted Reaction to Fed Minutes Shows Message Received

  • Futures traders see 66% chance of rate increase by December
  • Minutes confirm Fed expects to hike in December, Pimco says

Federal Reserve policy makers got their message across to Treasury traders last month, judging by the market reaction to meeting minutes released Wednesday.

The details of the Fed’s Oct. 27-28 policy session showed officials “intended to convey” that a December interest-rate increase may be appropriate, though no decision had been made. That effort proved successful Wednesday, as shown by muted moves in short-term Treasury yields and declining anticipated volatility across markets.

“The Fed minutes seemed like they were very much on-point for a liftoff in December,” said Craig Collins, managing director of rates trading at Bank of Montreal in London. “The market had been thinking a December hike was the most likely outcome, so it didn’t really have much of a market impact because it just supported that.”

Wednesday’s reaction contrasts with the confusion traders expressed after the Fed’s September statement, when officials cited a range of concerns, including international economic growth and market volatility. That month’s decision to keep rates near zero fueled the biggest rally in two-year Treasuries since 2009, and sent the probability of a December rate increase tumbling.

‘Message received!’

This time around, Fed officials have stuck with the message that they may raise interest rates by year-end. Richmond Fed President Jeffrey Lacker, New York Fed President William C. Dudley and Atlanta Fed President Dennis Lockhart all said on Wednesday that the Federal Open Market Committee’s conditions for an increase had been met.

“A reading of these minutes both confirmed that this committee expects it will hike in December and that the members clearly wanted to send that message,” Richard Clarida, the New York-based global strategic adviser at Pacific Investment Management Co., wrote in a report. “Message received!”

Pimco manages the world’s biggest actively run bond fund.

The two-year Treasury note yield was little changed at 0.88 percent as of 6:35 a.m. in New York on Thursday, versus the five-year closing high of 0.89 percent on Nov. 6, when a report showed surging U.S. job growth.

More Sensitive

Benchmark 10-year note yields fell one basis point, or 0.01 percentage point, to 2.26 percent. The 2.25 percent security due in November 2025 rose 1/8, or $1.25 per $1,000 face-amount, to 99 29/32.

The yield on 30-year bonds dropped three basis points to 3.02 percent.

Longer-dated securities outperformed shorter-term debt because the Fed will be raising rates in “an environment when you are not too concerned about inflation,” BMO’s Collins said.

Short-dated securities are more sensitive to the outlook for central-bank policy, while those that mature later are driven by the prospect of changes in consumer prices.

The U.S. plans to auction $13 billion of 10-year Treasury Inflation Protected Securities Thursday.

Price Stability

In another sign traders are taking a potential December rate increase in stride, many gauges of expected market volatility fell after the minutes were published.

The Bank of America Merrill Lynch MOVE Index, which measures price swings in U.S. debt, dropped almost 1 percent on Wednesday.

Traders expect a smoother ride in the market for stocks and currencies as well. The Chicago Board Options Exchange’s Volatility Index, which measures implied volatility in large-cap stocks, slid 11 percent on Wednesday, the biggest decline in nearly a month. The JPMorgan Global FX Volatility Index also fell.

“The Fed is doing a better job at communicating, because the message came out and it’s completely consistent with what they’ve been saying,” said Peter Tchir, head of macro strategy with Brean Capital LLC in New York. "It’s refreshing.”

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