Treasury Short-Term Note Yields Rise in 2014, Barclays Says

Treasury two-year note yields will rise to almost 1 percent by the end of 2014 as steady labor market gains lead investors to price in a boost to the Federal Reserve’s target rate by June 2015, according to Barclays Plc.

In an effort to hold down bond yields, the Fed might ratchet down its target for the unemployment rate to 6 percent from 6.5 percent in March, when it begins to taper its $85 billion a month in bond purchases, said Ajay Rajadhyaksha, co-head of fixed-income, currencies and commodities research at Barclays in New York.

“We see rates heading higher, despite the Fed wanting to prevent it, largely in the second half of the year,” Rajadhyaksha said. Should data hew to Barclays’s forecasts, “the Fed will have a hard time by the end of next year making the case that it plans to be on hold for a long time after 2014,” he said.

Barclays predicted the two-year yield will rise to 0.95 percent next year, compared with a median forecast of 0.9 percent in a Bloomberg News survey, from 0.27 percent yesterday in New York. It last touched 0.95 percent in May 2010. Two-year notes yielded 0.27 percent at 12:09 p.m. in New York.

The bank forecasts the 10-year yield to climb to 3.5 percent, versus 3.4 percent in Bloomberg’s survey, from 2.78 percent. The yield was 2.76 percent today.

Barclays also forecasts in its outlook for interest rates in 2014, which it is publishing today, that the U.S. gross domestic product will grow 2.5 percent next year, that unemployment will drop to 6.5 percent and the Fed’s preferred measure of inflation, the personal consumption expenditures index, will rise to 2.1 percent.

‘It’s Working’

While the bond market is now pricing in an increase in December 2015, labor-market growth of 200,000 jobs per month and the Fed’s progress toward ending bond purchases will lead investors to ramp up expectations for a Fed rate increase, Rajadhyaksha said.

By signaling that it will lower its unemployment goal, the Fed has bolstered its messaging that tapering doesn’t signal imminent rate increases, pushing the two-year Treasury yield down to a five-month low of 0.26 percent on Nov. 20 from 0.53 percent in September. “So far it’s working,” Rajadhyaksha said. “Sometime next year it will stop.”

The Fed will end its purchases in September and raise its benchmark overnight rate in June 2015 for the first time since the financial crisis in 2008, the bank predicts.

March Taper

Fed policy makers will decide to reduce the purchases to $70 billion a month at their March 18-19 meeting, according to the median forecast of 32 economist estimates in a Bloomberg survey on Nov. 8.

Interest-rate futures show an 11.1 percent probability that the Fed will raise borrowing costs by January 2015, down from 56.1 percent at the end of August.

By lowering its threshold for the unemployment rate, the Fed hopes to prevent a repeat of the rapid selloff that began in May lasting into September, which pushed 10-year yields up by more than 1 percentage point to 3 percent for the first time since July 2011, Rajadhyaksha said.

The 10-year yield will end June at 3 percent while the two-year Treasury note yield will rise to 0.5 percent by that time, Barclays forecasts. The firm see five-year note yields rising to 1.85 percent in June and to 2.5 percent by the end of 2014, from 1.3x percent yesterday.

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