U.S. 2-Year Notes Set for Worst Month Since November on Fed Bets

What Could Stop the Fed From Raising Rates?
  • Futures traders see 22% chance of June interest-rate increase
  • Economic data surpassing forecasts, Bloomberg index shows

Treasury two-year notes headed for their worst performance since November, the month before the Federal Reserve raised interest rates for the first time in nearly a decade, as traders added to bets that the officials may hike again as soon as next month.

Yields on two-year notes, the coupon securities most sensitive to Fed policy expectations, touched the highest in more than two months after a report showed personal spending exceeded forecasts in April. Economic data are surpassing analysts’ estimates by the most since January 2015, based on the Bloomberg ECO U.S. Surprise Index.

Throughout May, officials underscored the Fed’s intent to raise rates in 2016, perhaps more than once and as soon as June. Fed Chair Janet Yellen in an appearance Friday said policy makers would look to raise interest rates in the “coming months.” Futures traders assign a 22 percent probability of an increase in June, up from 4 percent three weeks ago, and a 76 percent chance of a hike by year-end. 

“Over the medium term, the greatest risk factor is monetary-policy exhaustion,” Kristina Hooper, U.S. investment strategist at Allianz Global Investors in New York, said in an interview on Bloomberg Television. “We’re getting close, and that seems to be one of the reasons the Fed is talking up the possibility of a June or July rate hike. They really do want to have some powder dry if things go south at some point with the economy.”

Yield Gap

The two-year yield was little changed at 0.91 percent as of 11:03 a.m. in New York after touching the highest since March, according to Bloomberg Bond Trader data. It has risen 13 basis points this month, or 0.13 percentage point, the most since November.

Benchmark 10-year notes pared losses, with yields rising one basis point to 1.86 percent.

Consumer purchases rose 1 percent in April, versus a forecast of 0.7 percent, and personal income climbed 0.4 percent for a second month, Commerce Department data showed Tuesday. A key measure of inflation rose 0.3 percent, the biggest gain since May 2015. 

To find the action in the Treasury market, look at the shrinking difference between two- and 10-year yields, said Kei Katayama, a bond manager in Tokyo at Daiwa SB Investments, which has about $50 billion in assets. The so-called spread contracted to 92 basis points Tuesday, the narrowest level in more than eight years.

Ten-year yields are being held down by investors seeking the most secure assets, Katayama said. The Fed meeting, an OPEC gathering, a U.K. referendum on whether Britain should stay in the European Union and an election in Spain may all provide reason to seek safety next month, he said.

“The market is preparing for June,” Katayama said. “There are so many events. There is considerable pressure for a risk-off scenario” that would fuel demand for the haven of Treasuries, he said. Katayama said he’s betting the two- to 10-year spread will keep shrinking.

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