Treasuries Rise as Producer Prices Highlight Fed Dilemma

Treasuries rose as a decline in wholesale prices by the most since 2009 highlighted the dilemma of the Federal Reserve’s plan to raise interest rates this year for the first time since before the global financial crisis.

The Fed has indicated it intends to raise borrowing costs with the labor market strengthening, yet inflation remains below its target, spurring concern any increase may hinder economic growth. Traders have been speculating that minutes of the Fed’s January meeting to be released later Wednesday will suggest it is moving closer to tightening, even after policy makers said they would be “patient” in deciding when to begin.

“These data might suggest the Fed could be patient despite the fact they continue to target in their speeches the middle of the year,” said Christopher Sullivan, who oversees $2.4 billion as chief investment officer at United Nations Federal Credit Union in New York, referring to producer prices.

Ten-year note yields fell one basis point, or 0.01 percentage point, to 2.13 percent at 1:33 p.m. New York time, according to Bloomberg Bond Trader data. The price of the 2 percent debt due February 2025 gained 1/8, or $1.25 per $1,000 face amount, to 98 7/8.

Two-year yields climbed to 0.69 percent, the highest since Jan. 5, before trading little changed at 0.65 percent. The yield on the note, more sensitive to expectations of changes in Fed policy than longer-term peers, was as low as 0.40 percent last month.

Wholesale Prices

A drop in the unemployment rate last month to an almost seven-year low of 5.7 percent came as the Fed’s preferred gauge of inflation, a measure tied to personal consumption, has stayed below policy makers’ 2 percent target since 2012.

The U.S. producer-price index fell 0.8 percent last month, the most since the series began in November 2009, Labor Department figures showed.

“If the outlook remains subdued on inflation, it allows them to leave ‘patient’ in,” said Sean Murphy, a trader at Societe Generale SA in New York, one of the 22 primary dealers that trade with the U.S. central bank. Policy makers have been “preparing the market for the option to go in June, and the market is pricing in that option.”

The gap between yields on 10-year Treasury inflation protected securities and nominal Treasury equivalents, seen as a measure of inflation expectations over the life of the securities, widened to 1.71 percentage points, from 1.49 percentage points Jan. 14, the lowest in more than four years. The five-year average is 2.18 percent.

Fed Speculation

Futures contracts indicate there’s a 58 percent chance the Fed will boost its benchmark rate target to at least 0.5 percent by September, data compiled by Bloomberg show. That’s up from a 39 percent probability at the end of last month. Markets show a 24 percent likelihood of an increase by June, versus a 14 percent chance seen on Jan. 30. Policy makers have kept the target in a range of zero to 0.25 percent since December 2008.

Treasuries rallied on Jan. 28 after the Fed released a statement maintaining its pledge to be patient on raising rates, while boosting its assessment of the economy and downplaying low inflation. Fed Chair Janet Yellen suggested at her December press conference the reference to patience meant the central bank is “unlikely to begin the normalization process for at least the next couple of meetings.”

The Fed’s next three meetings are in March, April and June. Yellen delivers her semi-annual policy report to Congress next week.

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