Treasury Buyers Foreseeing September Rates Liftoff Flatten Curve

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Treasury investors are starting to believe in a September interest-rate increase again.

Futures show a 42 percent chance the Federal Reserve will raise borrowing costs during that month, up from 35 percent odds a week ago, as Greece’s bailout agreement clears one of the obstacles to higher rates. The extra yield 30-year bonds offer over two-year notes shrank to the narrowest in five weeks on Monday after St. Louis Fed President James Bullard said the central bank has to start “thinking ahead” about a shift away from ultra-accommodative policy. Shorter maturities are more sensitive to the outlook for monetary policy than longer ones.

“The U.S. economy is strong enough for the Fed to remove what I believe are emergency levels of interest rates,” said Peter Osler, head of strategy at ED&F Man Capital Markets Ltd. in London. “If you think there are increasing chances of a Fed rate hike, that the Fed will be pre-emptive and has a good handle on inflation, then a flatter curve makes sense.”

The benchmark 10-year Treasury yield was little changed at 2.37 percent as of 6:42 a.m. in New York, according to Bloomberg Bond Trader data. The price of the 2.125 percent security maturing in May 2025 was 97 27/32 of face value.

Two-year notes yielded 0.7 percent, compared with 3.11 percent for 30-year bonds. The spread between the two contracted to 238 basis points Monday, the lowest since June 17, and was at 241 on Tuesday.

Falling Oil

Falling oil prices are also helping longer-dated Treasuries to outperform their shorter-term peers. That’s because inflationary pressures tend to show up more in 30-year yields than two-year rates.

Bullard of the St. Louis Fed told Fox Business Network on Monday that there’s a more than 50-50 chance U.S. officials will raise rates in September, adding that the economy is normalizing.

A Citigroup Inc. gauge of U.S. economic reports rose to the highest since February, while still signaling that data are lagging analysts’ forecasts. Across the Atlantic, Greece agreed on a bailout package with its creditors last week, easing concern that its exit from the euro zone would hobble global growth and delay the Fed in raising rates.

Yellen’s View

Fed Chair Janet Yellen told lawmakers last week that she expects officials to raise borrowing costs from near zero this year and to tighten policy gradually.

“While the recent fall in commodity and oil prices is unlikely to stop the Fed from going ahead with lift-off later this year, it may slow the pace,” said Peter Chatwell, a rates strategist at Mizuho International Plc in London.