Bond Market Moves Closer to Seeing No Fed Rate Increases in 2016

Goldman, Pimco: Traders Aren't Ready for Fed Hikes
  • Treasuries rally pushed 10-year yield to one-year low
  • TIPS outperform after Treasury Department cuts issuance

Bond traders are sending the clearest signal yet that they doubt the Federal Reserve will be able to raise interest rates this year.

The fixed-income market’s balance leaned toward zero rate hikes this year after a report showed U.S. service industries grew in January at the slowest pace since April 2014. Treasuries drew support from the data as well, briefly pushing the benchmark 10-year yield to a one-year low. The bond world’s skepticism about the Fed’s projected pace of four rate increases this year grew in January as sliding energy prices and stocks raised concern about policy makers’ ability to stoke economic growth.

Futures traders expect the Fed’s effective rate to be 0.51 percent by year-end. The metric fell as low as 0.47 percent Wednesday. That was closer to the current effective overnight rate of 0.38 percent than it was to 0.625 percent, where it may stand if the central bank raises its target range by a quarter-point again, following liftoff from near zero in December. Traders see a 47 percent chance the Fed will raise rates at or before its Dec. 14 meeting, down from a 93 percent probability assigned at the end of last year.

“The fall in the value of asset markets is a tightening of financial conditions,” Laurence Mutkin, head of G-10 rates strategy for BNP Paribas SA, said in an interview in New York. “It should affect central-bank policy, since it is tightening.”

Benchmark 10-year note yields rose four basis points, or 0.04 percentage point, to 1.89 percent as of 5 p.m. New York time, according to Bloomberg Bond Trader data. The 2.25 percent security due in November 2025 fell 3/8, or $3.75 per $1,000 face amount, to 103 7/32. The yield touched 1.79 percent, the lowest since February 2015.

‘Ultra-Sensitive’

Long-term yields, which are more sensitive to inflation expectations, rose while short-term yields were nearly flat, a reversal of a trend that sent the gap between two-year and 10-year Treasuries to its narrowest since 2008 on Tuesday. A weakening dollar and an 8 percent oil-price rally helped drive the move.

“When the U.S. dollar weakens, that alleviates some of the disinflationary pressures on the U.S. economy,” said Jack McIntyre, a money manager who oversees $58 billion at Brandywine Global Investment Management LLC in Philadelphia. “The market is being ultra-sensitive to this stuff.”

Investors have sought safety in U.S. debt this year on speculation that sliding commodity prices will drag down global growth and damp inflation. A Citigroup Inc. index shows U.S. economic data are falling short of forecasts by the most since June of last year. The Fed’s favored inflation gauge hasn’t reached its 2 percent target since 2012.

U.S. inflation-linked securities still jumped Wednesday on the Treasury’s announcement that it will cut issuance of Treasury Inflation Protected Securities, or TIPS.

Treasuries have earned 0.5 percent since Friday, when the Bank of Japan introduced negative interest rates for some deposits. This year, the market has posted a 2.7 percent return.

Financial conditions are “considerably tighter” than at the Fed’s last meeting, but it’s “too soon to draw any firm conclusions,” New York Fed President William C. Dudley said in an interview this week with Market News International. That followed comments from Fed Vice Chair Stanley Fischer that policy makers are undecided about what to do next after the recent turmoil in financial markets.

Before it's here, it's on the Bloomberg Terminal. LEARN MORE