Treasuries Fall as Fed Rate Speculation Halts Oil-Fueled Gains

  • Futures show 76% probability of rate increase this week
  • U.S. two-year note yield rises by the most since October

Treasuries tumbled, pushing 10-year yields up from near the lowest level in six weeks, amid speculation the Federal Reserve remains on course to raise interest rates this week even in the face of a rout in speculative-grade credit.

The move marked a turnaround after last week’s selloff in oil, stocks and high-yield bonds led investors to seek the safety of U.S. debt and pushed benchmark 10-year note yields to the lowest since October.

While oil dropped to an almost seven-year low earlier Monday, fixed-income assets across the globe declined as the U.S. central bank is poised to tighten policy in two days. The market volatility “won’t deter the Federal Reserve from raising interest rates on Wednesday,” Mohamed A. El-Erian, the chief economic adviser at Allianz SE, wrote in a Bloomberg column Monday. With an increase seen as probable, speculation has turned to whether policy makers will be inclined to reach normalized rates sooner than forecast.

“More focus is being given to how little the rates market has really priced in over the next few years,” said Aaron Kohli, a fixed-income strategist at Bank of Montreal, one of 22 primary dealers that trade with the central bank. “It’s more of a kitchen-sink kind of sale where investors aren’t being very discriminating about what they sell. The market doesn’t know exactly what to price in.”

The 10-year note yield climbed nine basis points, or 0.09 percentage point, to 2.22 percent as of 5 p.m. New York time, according to Bloomberg Bond Trader data. The 2.25 percent security due November 2025 fell 27/32, or $8.44 per $1,000 face amount, to 100 8/32. The yield dropped 10 basis points on Dec. 11, when it touched 2.12 percent, the lowest since Oct. 29.

‘Sustained Campaign’

The yield on the two-year note, the most sensitive to Fed policy moves, rose seven basis points to 0.94 percent. It was the biggest rise since Oct. 28, after the yield fell by the most since October on Dec. 11.

The probability traders assign an increase from the Fed at its meeting is 76 percent, according to futures data compiled by Bloomberg. The calculation is based on the assumption the effective federal funds rate will average 0.375 percent after liftoff, compared with the current range of zero to 0.25 percent.

“The Fed’s going to hike in the middle of the week, and people are focused on the potential for a sustained campaign toward normalizing rates,” said Ian Lyngen, a government-bond strategist at CRT Capital Group LLC in Stamford, Connecticut. While the market is looking beyond concerns about increasing credit risk and illiquidity in the high-yield market, those issues “might prove thematic into the end of the year,” he said.

A rate increase this week would come amid turmoil in speculative-grade credit markets. Lucidus Capital Partners, a high-yield fund founded in 2009, said Monday it has liquidated its portfolio and plans to return the $900 million it has under management to investors next month. Funds run by Third Avenue Management and Stone Lion Capital Partners have stopped returning cash to investors, after clients sought to pull too much money.

Oil rose for the first time in seven days after touching lows not seen since 2009, while U.S. stocks rallied as traders unwound bets on speculation last week’s pessimism may not be warranted amid continued economic expansion.

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