Treasuries Plunge as Economic Growth, Inflation Exceed Forecasts

  • Commerce Department revises fourth-quarter GDP data higher
  • Yield on two-year note rises by the most since December

Treasuries fell after a line-up of above-forecast economic data prompted traders to re-evaluate their views on the Federal Reserve’s interest-rates path.

Yields on two-year notes, seen as the most sensitive to Fed policy expectations, surged by the most since December as traders ratcheted up bets on the pace of rate increases. That helped push the gap between yields on two-year and 10-year notes to the narrowest since 2007.

Traders are evaluating their outlook for monetary policy before the Fed meets March 15-16. Futures markets imply traders expect the next rate increase in the second half of 2017, while the Fed’s median official projection in December indicated four hikes this year. Data Friday showed the central bank’s preferred gauge of price gains rose by the most since October 2014 -- though it remains below the Fed’s 2 percent target -- prompting a rise in market-based measures of inflation expectations.

“A lot of the over-exaggerated fears of recession risk in the U.S. probably moderated to some degree” said Chris Sullivan, who manages more than $2 billion as chief investment officer at United Nations Federal Credit Union in New York. “Growth in the U.S. is still tenuous at best, but the current quarter is probably a bit better than the fourth quarter.”

The benchmark Treasury 10-year note yield rose five basis points, or 0.05 percentage point, to 1.76 percent as of 5 p.m. New York time, according to Bloomberg Bond Trader data. The 1.625 percent security due in February 2026 fell 14/32, or $4.38 per $1,000 face amount, to 98 24/32.

Changing Tone

The yield on the two-year note surged seven basis points to 0.79 percent, the highest on a closing basis since Feb. 1.

Gauges of U.S. price growth, economic growth, consumer spending and consumer sentiment all came in above economist estimates.

“The overall tone of the economic data has changed a little, and that’s what has been causing the selling,” said Thomas Simons, a money-market economist at Jefferies Group LLC in New York, one of 22 primary dealers that trade with the Fed.

The Citigroup U.S. Economic Surprise Index has climbed for three consecutive days, and is near its high for the year. While the index is still negative -- indicating economic data is still worse than expected -- it climbed to negative 21.4 on Friday, well above its year-to-date low of negative 55.7.

Derivatives traders see a 53 percent chance the Fed will raise rates by the end of this year, up from 38 percent Thursday, according to overnight indexed swaps data compiled by Bloomberg, assuming the effective fed funds rate will average 0.625 percent after the Fed’s next hike.

The Treasury Department auctioned $28 billion of seven-year notes at a yield of 1.568 percent. The sale, which was postponed from Thursday, drew the lowest demand since 2009 as measured by the ratio of accepted bids to securities being offered.

‘Lowflation’ Call

Goldman Sachs Group Inc. analysts wrote in a Thursday note they expect gains in another inflation metric, the consumer-price index, to average 1.3 percent this year, and to accelerate to 2.4 percent in 2017. The analysts said they expect “lowflation” rather than deflation.

The analysts said the gauges of inflation compensation demanded by traders are being suppressed by technical market factors. They pointed to research on inflation-linked debt from the Atlanta Fed showing markets implied just a 6 percent probability of deflation between 2015 and 2020 on Feb. 9, a day before a closely followed market-based gauge of inflation expectations known as the 10-year break-even rate fell to its lowest since 2009. That rate, which measures the gap between yields on 10-year notes and comparable Treasury Inflation-Protected Securities, rose for a sixth day to 1.42 percent on Friday.

“Despite our inherent disagreement with inflation markets on break-even levels, we -- along with other economists responding to the Philadelphia Fed’s Survey of Professional Forecasters -- do agree with TIPS and assign a very low probability for outright deflation in the coming year,” the analysts wrote.

Long-term consumer expectations for inflation between the next five and 10 years rose to 2.5 percent in February, according to a survey released Friday by the University of Michigan.

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