Treasuries Fall as Jobs Gains Raise Odds for Fed Rate Increase

The Treasury market is signaling the latest jump in U.S. employment will leave the Federal Reserve little excuse not to raise interest rates this year.

Yields on two-year notes, most sensitive to changes in expectations for central-bank policy, climbed to the highest level this year after a government report showed the economy gained more jobs than forecast in February and the unemployment rate dropped to an almost seven-year low. Futures showed the odds of a rate increase in September climbed to 60 percent from 49 percent on Thursday.

“History suggests it’s not inflation expectations that move bond yields over the short-run, it’s the expectation of what the Fed is going to do,” said James Kochan, chief fixed-income strategist at Wells Fargo Funds Management LLC in Menomonee Falls, Wisconsin. “We’re building in an expectation that rates are going to up.”

The central bank has kept its target for overnight loans between banks in a range of zero to 0.25 percent since December 2008 to support the economy. It last raised the rate in 2006.

Yields on benchmark 10-year notes rose to their highest level this year Friday, climbing 13 basis points, or 0.13 percentage point, to 2.24 percent at 5 p.m. New York time, according to Bloomberg Bond Trader data. They bottomed out at 1.64 percent on Jan. 30, the lowest since May 2013.

Two-year note yields climbed as much as nine basis points to 0.73 percent, the highest level since Dec. 29.

Jobs Report

Yields soared after the Labor Department reported the U.S. added 295,000 jobs last month, compared with a forecast for a 235,000 gain in a Bloomberg survey. The unemployment rate fell to 5.5 percent from 5.7 percent.

It was 12th straight month payrolls have increased by at least 200,000, the best run since March 1995. Payrolls rose 3.1 million in 2014, the most in 15 years.

“You see a coalescing of expectations about a June start to Fed tightening,” said Michael Cloherty, head of U.S. rates strategy in New York at Royal Bank of Canada’s RBC Capital Markets unit, one of 22 primary dealers that trade with the Fed. “That shift will be strong enough that the debate will turn away from, ‘when’s the first hike?’ and more towards the pace and peak of the fed funds rate.”

‘First Steps’

Federal Reserve Bank of San Francisco President John Williams said mid-year may be time for a “serious discussion” about raising interest rates as the labor market nears full employment and inflation rebounds.

“The time is coming when we’ll be making our first steps down the road to normalization,” Williams said Thursday in the text of a speech prepared for delivery in Honolulu. “What I see when I look at the data that strip out the short-term volatility is an economy that’s got a good head of steam and is getting close to full employment.”

The U.S. central bank had boosted its assessment of the economy on Jan. 28 after a two-day meeting. Policy makers played down low inflation while saying the U.S. was growing at a “solid” pace, versus the “moderate” performance they saw in December, when they signaled they were on track to raise rates this year.

“It inevitably was going to pull people’s expectations a little forward because the marketplace just hasn’t believed the Fed, because they’ve changed the goal posts so many times to delay the liftoff,” said Guy Haselmann, an interest-rate strategist at Bank of Nova Scotia in New York, one of 22 primary dealers that trade with the Fed. “People are starting to realize the Fed risks looking like it’s falling behind the curve.”

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