Bond Traders Get Nudge to Focus on Homefront in Fed Forecasting

  • Two-year Treasury yields reach highest since Sept. 17
  • Prospect of U.S. government shutdown also draws attention

The Treasuries market got the all-clear from the Federal Reserve to focus its attention closer to home.

Two-year yields reached the highest in more than a week after Fed Chair Janet Yellen signaled in a speech Thursday that turmoil beyond U.S. shores may prove less of an obstacle for policy makers than traders concluded after the central bank left its benchmark rate near zero on Sept. 17.

Traders took that as a sign that they can concentrate on the U.S. economy in divining the Fed’s path, and tune out some of the turbulence abroad that policy makers referenced in their Sept. 17 decision.

“They still believe the economy is strong enough to accept these anticipated hikes,” said Larry Milstein, managing director of government-debt trading at R.W. Pressprich & Co in New York. “Before, there was the view in the market that maybe the Fed was changing their opinion, and that there was some concern about what was going on globally.”

Two-year yields climbed one basis point on the week, or 0.01 percentage point, to 0.69 percent, after touching the highest since Sept. 17. The 0.625 percent note due in September 2017 ended the week at 99 27/32.

Traders’ Relief

Yellen’s remarks brought relief to strategists and traders who were left re-examining their approach to Fed forecasting last week after she cited a range of concerns in explaining the decision to keep the benchmark rate near zero, where it’s been since 2008.

If this week’s trading is any indication, domestic concerns are moving to the forefront.

On Sept. 22, before Yellen’s speech, a global equities selloff sparked a Treasuries rally and led traders to reduce the chances of a 2015 increase to 39 percent, from 49 percent the day before. The calculation is based on Bloomberg data that assumes the fed funds rate will average 0.375 percent after Fed liftoff.

Domestic Precedence

Then on Friday, U.S. developments took precedence. Treasury yields fell from their highest levels of the day after U.S. House Speaker John Boehner announced that he’ll resign from Congress at the end of October. In the eyes of some traders, the move reduces the likelihood of a government shutdown as soon as next week, while raising the specter of a stalemate later in 2015.

“There’s still a lot of unresolved risk issues, and I think the Fed’s moved down the list,” said Jim Vogel, head of interest-rate strategy at FTN Financial in Memphis, Tennessee.

In the week ahead, traders will have to sift through a batch of comments from Fed officials, starting Monday, when Federal Reserve Bank of New York President William C. Dudley speaks in New York. Yellen is scheduled to talk about community banking with Fed Bank of St. Louis President James Bullard on Sept. 30.

Treasuries investors are also looking to the Oct. 2 release of September labor data. The U.S. probably added about 200,000 nonfarm jobs, according to the median forecast of analysts in a Bloomberg survey.

Inflation Judgement

While Treasuries were little changed this week, the bond market’s pricing of inflation expectations sank to the lowest since 2009. Fed officials have missed their 2 percent inflation target for more than three years amid falling energy costs and an appreciating dollar.

Yellen expressed confidence that a portion of the inflation undershoot will wash out as the effects of energy and import prices fade.

She included herself in the camp of policy makers viewing an interest-rate increase as probably being warranted by year-end. That characterization wasn’t included Sept. 17, when she said that “most participants” concluded a rate rise this year would be appropriate.

“She identified herself as one of those who are looking for one hike this year,” said Priya Misra, the head of global interest-rates strategy at TD Securities in New York. “The market pays more attention to her forecast.”

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