Treasury Two-Year Debt Set for Worst Month Since November on Fed

Negative Interest Rate Cycle Holding Back the Fed
  • September rate-hike odds reach almost 40%, from 24% a week ago
  • Longer maturities rally amid month-end rebalancing move

Two-year Treasury notes are on pace for their worst monthly performance since November as traders add to bets that the Federal Reserve will increase interest rates as soon as next month.

The coupon maturity most sensitive to Fed expectations is coming off its steepest weekly selloff since May after Fed Chair Janet Yellen said in a speech that policy makers “anticipate that gradual increases in the federal funds rate will be appropriate over time to achieve and sustain employment and inflation near our statutory objectives.” Her remarks put the spotlight on labor figures due Sept. 2, which are projected to show the economy added 180,000 jobs in August, following a gain of 255,000 in July.

With the Fed decision looming about three weeks away, shorter maturities trailed gains on Monday in longer-dated debt, which was also attracting demand because of month-end buying, traders said. The extra yield that 30-year bonds offer over five-year notes shrank to the least in more than a year.

"They’re likely to tighten in September, at least as long as the jobs number comes in OK," Michael Pond, head of global inflation market strategy at Barclays Capital Inc. in New York, said on Bloomberg Television. "Hawkish Fed rhetoric has certainly increased recently. It’ll take a decent number, like 200,000, for them to go."

The two-year Treasury yield dropped four basis points, or 0.04 percentage point, to 0.81 percent as of 5 p.m. in New York, according to Bloomberg Bond Trader data. The yield has climbed about 15 basis points in August. The price of the 0.75 percent security due in August 2018 was 99 28/32.

Month End

Yields on thirty-year securities dropped seven basis points, the most in about four weeks, to 2.21 percent, amid month-end purchasing by funds to match duration benchmarks.

Fed funds futures indicate a 36 percent chance that the central bank will raise rates next month, up from 24 percent a week ago, and zero in late June after the U.K. voted to leave the European Union. The probability of an increase by December has risen to about 60 percent from a low of 8 percent reached June 27, according to futures data compiled by Bloomberg. The calculation assumes the effective fed funds rate will average 0.625 percent after the central bank’s next increase.

Pacific Investment Management Co. is reducing Treasuries and favors inflation-linked bonds, according to Scott Mather, chief investment officer of U.S. core strategies and a managing director at Pimco.

“With respect to Treasuries and nominal Treasuries, we’re continuing to reduce those, so we hold far less than our benchmark there," Mather said on Bloomberg Television. "We’re looking for pockets of value, which in the bond market, we see in things like inflation-linked bonds."

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