September Fed-Hike Window Starting to Close for Bond Traders

JPM's Kelly: No Need to Stimulate Economies
  • Futures imply about 24% chance of increase this month
  • Bets fade as central bankers are set to speak this week

Bond traders are showing their doubts about the possibility of an interest-rate hike by the Federal Reserve this month after a report showed U.S. service industries expanded at the slowest pace in six years.

Treasuries yields fell across maturities Tuesday as the data came in below the most pessimistic projection in a Bloomberg survey. The result jolted the bond market from a state of limbo after a lukewarm reading on August payrolls, released Sept. 2, gave no clear signal on the timing of a rate increase.

The market-implied probability of a rate boost at the Federal Open Market Committee’s Sept. 20-21 meeting slumped to 24 percent, the lowest since Aug. 22. The calculation assumes the effective fed funds rate will trade at the middle of the new target range after any increase. Federal Reserve Bank of San Francisco President John Williams said the central bank may raise rates at any of its meetings.

Coming after data last week showed a surprise contraction in manufacturing, the latest report led traders to roll back bets on a September hike just as a slew of Fed officials are set to sound off. 

“This just confirms the suspicion that as much as the Fed may want to hike this year, the data has to be there,” said David Tulk, head of global macro strategy in Toronto at Toronto-Dominion Bank, which forecasts no rate hike this year. “If the data continues to soften heading into the FOMC meeting, expectations will be pared back and Treasuries will continue to rally.”

The yield on the two-year Treasury note, the coupon maturity most sensitive to Fed policy expectations, fell six basis points, or 0.06 percentage point, to 0.73 percent Tuesday. It was little changed Wednesday at a price of 100 as of 6:47 a.m. in London.

The economy is “in good shape and headed in the right direction,” the Fed’s Williams said in the text of a speech in Reno, Nevada. “Every meeting is live, we want to have a serious discussion,” Williams told reporters when asked if September is on the table. The path for U.S. interest rates is flatter than he thought a year ago, he said. Williams doesn’t vote on monetary policy this year.

In the lead-up to last week’s labor report, Fed Chair Janet Yellen had revived bets on a September hike in an Aug. 26 speech in Jackson Hole, Wyoming, where she said that the case for raising rates this year had strengthened.

Traders can look to several Fed officials this week for signals on how they’re interpreting the data. Richmond Fed’s Jeffrey Lacker and the Kansas City Fed’s Esther George are among policy makers slated to speak.

The services data "suggest that the market will be tipping towards no Fed hike in September," said Aaron Kohli, a fixed-income strategist at BMO Capital Markets Corp. in New York. Shorter maturities will lead gains until "we get either a Fed speaker or additional data to counteract that view.”

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