Fed Hawks Consign Treasuries to Worst Month Since June 2015

  • Credit Agricole favors curve-flattening trades in Treasuries
  • Longer-term notes may sidestep brunt of rate move: DBS’s Leow

Treasuries are heading for their worst month since June of last year after Janet Yellen and a chorus of Federal Reserve officials said the case for higher interest rates had strengthened.

Short-dated notes have underperformed their longer-dated counterparts, with the yield on two-year securities, the most sensitive to the monetary policy outlook, climbing in August by the most since November. That came as the odds of a rate increase this year jumped following Fed Chair Yellen’s Aug. 26 remarks.

The shift in investor perception strengthened after Vice Chair Stanley Fischer reiterated that the path will depend on incoming data, while expressing optimism on the economy. He previously said a jobs report this Friday will be key. The spread between two-year versus 30-year yields reached the narrowest since January 2008 on Tuesday.

“Fed policy makers are trying to tell the market that one hike this year is still likely as there still seems to be a disconnect between the market and the Fed thinking,” said Mohit Kumar, head of rates strategy at Credit Agricole SA’s corporate and investment banking unit in London. “The market was way too complacent about the Fed. I like curve-flattening trades in the U.S. as the front-end can sell off if the Fed moves more to the hawkish side.”

A curve-flattening trade is done by positioning for the yield spread to narrow between shorter-dated notes and longer-dated securities.

The Bloomberg Barclays US Treasury Index has declined 0.6 percent in August, set for the biggest monthly loss since June last year.

The two-year yield was little changed at 0.81 percent as of 7:35 a.m. in New York, up this month by 15 basis points, or 0.15 percentage point, according to Bloomberg Bond Trader data. The price of the security due in August 2018 was 99 28/32. The spread with 30-year Treasuries was little changed at 143 basis points, after narrowing to as little as 140 basis points Tuesday, an eight-year low.

Rates Probability

Fed fund futures signal 34 percent odds of tighter policy at the Sept. 20-21 meeting, according to data compiled by Bloomberg. The market-implied probability climbed to 42 percent after Yellen’s speech, from 18 percent at the start of the month. It had dropped to zero in late June after the U.K. voted to leave the European Union.

Friday’s labor report is projected to show U.S. employers added 180,000 jobs in August following a gain of 255,000 in July. The monthly labor force number has exceeded expectations the past two readings, pointing to renewed vigor in the employment market.

Kansas City Fed President Esther George last week reiterated her call that higher rates are warranted, while Dallas chief Robert Kaplan said “the case is strengthening” for another increase. They joined New York’s William Dudley and his San Francisco counterpart John Williams who signaled earlier in August an increase could be on the table in coming months.

“There are two views on where to seek refuge if the Fed normalizes policy as communicated,” said Eugene Leow, a fixed-income strategist at DBS Group Holdings Ltd. in Singapore. “Heading to the very front of the U.S. Treasuries curve would minimize duration risks, but forgos the yield pickup. Alternatively, longer-term Treasuries have been relatively stable and should sidestep the brunt of the normalization cycle.”

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