September Fed Bets Jump to 1-in-3 From Zero as Yellen Speech Key

Dallas Fed's Kaplan: Rates Should Be Raised 'Patiently'
  • Two-year Treasury note yields poised to rise for second week
  • Probability of September rate hike ‘relatively low’: Pimco

Traders see one-in-three odds of higher U.S. interest rates next month as more Federal Reserve officials joined the chorus arguing the case for policy tightening before Chair Janet Yellen speaks Friday.

QuickTake The Fed Lifts Off, Barely

Implied probability in futures markets of 32 percent is double what it was two weeks ago, and up from zero after the U.K. voted to exit the European Union in June. Two-year Treasury yields, which are more sensitive than longer maturities to the monetary policy outlook, were poised to rise for a second week after Kansas City Fed President Esther George reiterated her call that higher rates are warranted, while Dallas Fed chief Robert Kaplan said “the case is strengthening” for another increase.

“Yellen will try to maintain the possibility that they could go in September,” said Martin van Vliet, an interest-rate strategist at ING Groep NV in Amsterdam. “At the same time, she will stress there is still a lot of risk out there, which in my view makes a September hike less likely and the market agrees - it is just one-in-three. It will be a tight balancing act.”

The two-year Treasury note yield climbed four basis points, or 0.04 percentage point, this week to 0.79 percent as of 6:50 a.m. in New York, according to Bloomberg Bond Trader data. The price of the 0.75 percent security due in August 2018 was 99 30/32. The spread between two- and 30-year yields closed Thursday at the narrowest since 2007.

The comments by George and Kaplan came after New York Fed chief William Dudley and his San Francisco counterpart John Williams signaled a rate increase could be on the table in coming months. Vice Chair Stanley Fischer said Sunday the U.S. economy is close to the central bank’s goals and he expects growth to pick up in the future.

“The probability of a September rate hike, we think is still relatively low,” Mike Amey, a London-based money manager at Pacific Investment Management Co., said in an interview on Bloomberg Television. “The last set of minutes were not particularly hawkish. So they’ve had the opportunity to take a more aggressive stance for September if they wanted to, but we do think there’s a decent chance they move before the end of the year.”

The chance U.S. policy makers will raise rates by year-end is 57 percent, up from 36 percent at the end of July, according to data compiled by Bloomberg based on fed fund futures.

Fed’s Toolkit

Yellen’s speech is scheduled for 10 a.m. New York time. The formal topic of her remarks -- “The Federal Reserve’s Monetary Policy Toolkit” -- implies a technical focus on the challenges facing the central bank in an era of tepid growth and low inflation. Investors will scrutinize any description of the economy in the chair’s first public comments since June that will clarify if the Fed remains on track to raise rates later this year. Its next meeting is Sept. 20-21.

Watch Next: Are Risk Assets Less Buoyant With a Hawkish Fed?

If Yellen continues the confident tone of some of her colleagues, “market expectations for a September rate increase will likely move up closer to 60 percent to 70 percent,” said Sean Keane, an Auckland-based analyst at Triple T Consulting and a former head of Asia-Pacific rates trading at Credit Suisse Group AG.

In the past decade, Jackson Hole has only been a “big market mover” in 2010, when then Fed chief Ben Bernanke signaled more quantitative easing, Bank of America Merrill Lynch strategists led by Michael Hartnett said in a note dated Aug. 24. Still, it has potential to cause volatility this year as markets have been pricing in a “dovish Fed” since February, they wrote.

Bank of America Corp.’s MOVE Index, which measures price swings in U.S. debt, climbed to the highest level in a month. It rose to 69.36 from an almost 20-month low of 63.34 on Aug. 10.

Yellen is “trying to tread this slightly tricky path where the Fed wants to hike rates but everyone else is going in the opposite direction,” Pimco’s Amey said.

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