Treasury Curve Flattest in 10 Months Shows Trust in Fed's Yellen

  • Fed chair has stressed measured pace in raising interest rates
  • December liftoff bets hand 2-year notes worst month since 2009

The Treasury market is taking Janet Yellen at her word on the path for monetary policy.

The yield premium offered by 10-year notes over two-year securities narrowed to the least in 10 months as the Federal Reserve chair has stressed the potential for liftoff this month, while reiterating that tightening will proceed at a measured pace. A flattening of the so-called yield curve suggests investors see interest rates rising slowly. Yellen is scheduled to speak publicly again Wednesday and Thursday.

“The Fed is going to be hiking interest rates very, very slowly,” said Birgit Figge, a fixed-income strategist at DZ Bank AG in Frankfurt. “The curve will surely flatten,” she said, adding that Treasury 10-year yields could shoot up after the Fed tightens policy but she doesn’t see a “lasting trend to really higher rates of 3.5 percent.”

The yield on the benchmark 2.25 percent note due in November 2025 rose one basis point, or 0.01 percentage point, to 2.16 percent as of 6:56 a.m. New York time. It reached 2.14 percent Tuesday, the lowest since Nov. 2. The price of the security fell 1/8, or $1.25 per $1,000 face amount, to 100 26/32.

Figge said DZ Bank was rethinking its forecast of four Fed rate increases in 2016 and predicted 10-year yields would rise at a “moderate pace” to 2.35 percent by March next year and 3 percent by the end of 2016.

The extra yield 10-year notes offer over two-year debt shrank to as little as 123 basis points on Tuesday, the least since Feb. 3. The yield premium offered by 30-year bonds over two-year paper dropped below 199 basis points on Wednesday, the lowest since April 14.

“Even Yellen doesn’t believe in a really strong recovery,” said Kei Katayama, a bond manager in Tokyo at Daiwa SB Investments, which oversees about $47 billion. “Which is why she is trying to persuade market participants that she will do a more measured, slow tightening.”

Katayama sees the potential for yields to rise on Treasuries maturing in five years or less, while those on longer-term securities fall. He doesn’t expect 10-year note yields to go below 2 percent.

Fed Meeting

Yields on two-year securities climbed 21 basis points in November, the most of any month since December 2009, amid rising bets for the first boost in interest rates in almost a decade at the Federal Open Market Committee’s Dec. 15-16 meeting.

Futures indicate the odds are at 72 percent, from 50 percent at the end of October, data compiled by Bloomberg show. The calculation is based on the assumption that the effective fed funds rate will average 0.375 percent after the first increase, compared with the current range of zero to 0.25 percent.

As the Fed decision draws closer, the focus on U.S. economic releases has intensified given that Yellen and other Fed policy makers have signaled that the policy path will be data-dependent. Chicago Fed President Charles Evans said on Dec. 1 that he’d like to see more evidence of strengthening economic growth and inflation.

Treasuries surged on Tuesday, driving 30-year bond yields down by the most since September, after data showed that U.S. manufacturing unexpectedly shrank in November at its fastest pace since 2009, underscoring expectations that the Fed will refrain from aggressive policy tightening.

Investors will watch payrolls data on Friday which, according to the median forecast in a Bloomberg survey, will show U.S. employers probably added at least 200,000 jobs for the second straight month in November.

(An earlier version of this story was corrected to show the day the 10-year note yield reached a low.)

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