Bond Traders Caught Napping as Fed Talks Tough on June Meeting

The Fed Sets the Table for a June Rate Hike
  • Odds of June rate increase climbs to 32% from 4% on Monday
  • ‘This is a pain move,’ Bank of Tokyo-Mitsubishi’s Rupkey says

It took only a few days for interest-rate anxiety to flood back into the bond market.

After dismissing the chance of a Federal Reserve rate increase in June, traders reversed course Wednesday when minutes from the most recent Federal Open Market Committee meeting sent yields soaring. Most officials said at the April gathering that a move in June would be warranted if economic data indicate stronger growth and inflation.

Two-year yields jumped to the highest since March following the release as traders boosted the probability of a June increase to 32 percent, from just 4 percent at the start of the week. Ten-year Treasuries slid for a fourth day Thursday.

“What’s unsettled markets is the fact they had completely priced out June,” said Gregory Peters, a senior investment officer at Prudential Financial Inc.’s fixed-income unit, which oversees about $621 billion in Newark, New Jersey. “So that’s kind of a shock to the system.”

U.S. 10-year note yields rose two basis points, or 0.02 percentage point, to 1.88 percent as of 6:20 a.m. in New York, according to Bloomberg Bond Trader data. The 1.625 percent security maturing in May 2026 fell 6/32, or $1.88 per $1,000 face amount, to 97 23/32. The yield jumped eight basis points Wednesday, the biggest increase since March 1.

Traders Jolted

The minutes jolted traders who’d nearly ruled out a June increase after a weaker-than-forecast report on April jobs growth released May 6. Following those statistics, traders’ expectations for Treasury-market volatility slid to the lowest since December 2014, according to the Merrill Option Volatility Estimate index.

“You can see that this is a pain move” in the markets, said Chris Rupkey, chief financial economist at Bank of Tokyo-Mitsubishi UFJ Ltd. in New York. “Somebody’s really in pain, they’re losing money.”

The declines in Treasuries came even after two Fed officials primed the market for a hawkish view. Regional Fed presidents Dennis Lockhart and John Williams said Tuesday that at least two rate increases would be warranted this year because the economy is expanding and inflation is quickening.

Market ‘Complacent’

“The tone of the minutes caught many by surprise, and I think the risk-reward is for a short position in the front end of the U.S. curve,” said Mohit Kumar, head of rates strategy at Credit Agricole SA’s corporate and investment-banking unit in London. “The market was very complacent. That said, I don’t think a rate hike in June is imminent. The FOMC needs to see very convincing data to be sure of a move next month. The latest jobs data, while decent, wasn’t convincing enough.”

Hideo Shimomura at Mitsubishi UFJ Kokusai Asset Management is even more skeptical, and said he’s sticking to his forecast for the central bank to stay on hold in 2016.

“Even if the Fed hikes, it won’t affect long-term yields much,” said Shimomura, who’s chief fund investor in Tokyo at the company which manages $109 billion. “I’d say that job creation won’t continue at the present pace. Long-term yields might head south.”

Ten-year yields will fall to 1.25 percent by Dec. 31, he said, exceeding a record low of 1.379 percent reached in 2012.

Moody’s Investors Service said it expects the Fed to raise its benchmark twice this year “at most.” The company lowered its 2016 growth forecast for the U.S. economy to 2 percent from 2.3 percent to account for a weak first quarter.

The Fed is steering the market into line with its views, said John Gorman, head of U.S. debt trading for Asia and the Pacific in Tokyo at Nomura Holdings Inc., one of the 23 primary dealers that trade directly with the U.S. central bank.

“They did a very good job,” he said. “I’m still not sure they go in June. In my mind, I’m absolutely positive they go in September.”

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