U.S. Curve Flattens as Fed's Preferred Price Gauge Remains Tame

  • Slow pace of rate boosts may benefit longer-term debt
  • Treasury sells seven-year notes at highest yield since July

Is the Global Economy Ready for a Fed Rate Hike?

The yield difference between two- and 10-year Treasuries shrank to the narrowest since February amid tame inflation and as some of the world’s biggest money managers say the market is ready for the first Federal Reserve interest-rate increase in almost a decade.

BlackRock Inc., which manages $4.5 trillion, says U.S. monetary policy will still be stimulative after the first boost. Pacific Investment Management Co., with $1.47 trillion, says Fed Chair Janet Yellen has prepared investors for a gradual pace of tightening.

With inflation expectations in check, longer-dated Treasuries are outperforming, reducing the extra yield they offer over shorter maturities -- flattening the yield curve in bond-trader lingo. The Commerce Department said Wednesday that its price index tied to consumer spending rose 0.2 percent in October from a year earlier. The Fed’s preferred price-growth gauge has been below its 2 percent goal since 2012.

"I’m not so sure we’re going to get such a meaningful rise in bond interest rates," David Kotok, chairman and co-founder of Cumberland Advisors, which manages $2.4 billion of fixed income in Sarasota, Florida, said on Bloomberg Radio. "The longer end flattens; we don’t steepen the yield curve when the Fed moves, we flatten it."

The benchmark U.S. 10-year note yield was little changed at 2.23 percent as of about 5 p.m. New York time, according to Bloomberg Bond Trader data. The price of the 2.25 percent security due in November 2025 was 100 1/8. The yield touched 2.2 percent Tuesday, the lowest since Nov. 4

Investors waded through a spate of U.S. economic data on Wednesday amid the holiday-shortened week. U.S. bond markets will shut Thursday for Thanksgiving Day and open for a partial session Nov. 27.

First-time jobless claims dropped by 12,000 in the week ended Nov. 21 to 260,000, the fewest in a month, a government report showed Wednesday. U.S. consumer confidence rose less than forecast in November, according to a University of Michigan index.

The Treasury sold $29 billion of seven-year debt at a yield of 2.013 percent, the highest for the maturity since July. The sale was part of a combined tally of more than $100 billion of note offerings this week. The bid-to-cover ratio, a gauge of demand, was 2.51, above the 2.46 average for the past 10 sales.

Fed Hurdle

"This was another hurdle day that you have to get through for something not to go wrong, and nothing went wrong for the Fed," said David Keeble, head of fixed-income strategy at Credit Agricole SA in New York.

The narrowing Treasury market spread signals a growing consensus the Fed will raise its benchmark from near zero at its Dec. 15-16 meeting and boost rates gradually thereafter. Two-year yields, among the most sensitive to central bank policy, have jumped about 0.2 percentage point this month. Ten-year yields have dropped the past two weeks. The difference between the two is about 1.3 percentage points, the smallest on a closing basis since Feb. 4.

“Put the current potential rate hike in context,” Russ Koesterich, global chief investment strategist at New York-based BlackRock, said in an interview Tuesday. “We’re going from zero percent to potentially a quarter percent. That’s hardly restrictive monetary policy.”

Policy makers crafted their last statement in October to stress that it may become appropriate to raise the benchmark rate in December, and they largely agreed the pace of increases would be slow, minutes of the meeting showed.

The probability the Fed will raise rates by year-end is at 74 percent, close to the highest since August. The calculation is based on the assumption that the effective fed funds rate will average 0.375 percent after liftoff, compared with the current range of zero to 0.25 percent.

Yellen is preparing investors for a program of rising rates that will be “the most gradual in history,” Richard Clarida, Pimco’s New York-based global strategic adviser, wrote in a report this week.

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