No More Distractions for Treasuries as Fed Focus Flattens Curve

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Treasury investors are turning their attention back to the Federal Reserve, after recent turmoil offered distraction from the world’s worst sovereign debt performance behind Japan and Greece.

The difference between yields on two- and 30-year government debt narrowed the most in four months in a week when Greece signed a bailout deal and a bear-market rout in Chinese stocks stabilized. Concern has eased that a fragile global economy would delay the Fed’s first interest-rate increase since 2006. Chair Janet Yellen made it plain over two days of testimony before Congress this week she believes the central bank can raise borrowing costs in 2015.

“The uncertainty around Greece and China could be over, and that means the market theme is shifting to the probability of a Fed rate hike -- and the most important thing is when,” said Hiroki Shimazu, a senior market economist at SMBC Nikko Securities Inc. in Tokyo. Treasuries are too expensive, and the 10-year yield will advance to around 3 percent by year-end, he said.

The benchmark 10-year Treasury yield was little changed at 2.35 percent as of 6:49 a.m. in London, according to Bloomberg Bond Trader data. It has fallen 5 basis points this week. The price of the 2.125 percent security due in May 2025 was 98 2/32.

The difference between yields on two- and 30-year government debt has narrowed 11 basis points since July 10 to 244 basis points, the least since July 9. The shorter bond’s yield, which is more sensitive to central-bank policy, has risen two basis points, while the long bond’s fell nine basis points.

Lagging Performance

Treasuries have returned 2.4 percent in the past 12 months, data compiled by Bloomberg and the European Federation of Financial Analysts Societies show, as the Fed moves closer to normalizing policy. That’s the worst performance after a 1.9 percent gain in Japanese government bonds and a 26 percent loss for Greek sovereign debt.

Yellen said Wednesday that central-bank officials may raise rates this year if economic growth matches up with their projections. Fed funds futures show a 35 percent chance the central bank will increase its benchmark rate at its September meeting from virtually zero, and 67 percent odds for a rise by year-end, according to data compiled by Bloomberg.

Treasury market volatility has tumbled this week. The Bank of America Merrill Lynch MOVE Index, which tracks price changes based on options trading, fell to 76 basis points on Thursday, the lowest level since April 30.

“She’s laid down this foundation for a rate hike this year, and volatility is falling,” Chris Weston, chief market strategist at IG Ltd. in Melbourne, said in an interview with Bloomberg. “I think that’s a very positive thing.”

(A previous version of this story was corrected to give the right gap between two- and 30-year yields.)