Bond Traders Skeptical on Fed Rate Path Before December Minutesby
Derivatives market implies Fed target at about 0.9% in a year
Global volatility, tame inflation keeping Treasury yields low
Treasuries were little changed before Wednesday’s release of the minutes of the Federal Reserve’s December policy meeting as traders doubt officials will be able to raise interest rates as often as they envision.
U.S. government debt edged higher after rallying the most in two weeks on Monday when a contraction in Chinese manufacturing triggered a global equities rout. The derivatives market is pricing in slightly more than two Fed increases in 2016, compared with the four moves that Federal Open Market Committee members laid out in their latest quarterly forecasts. Interest-rate derivatives traders see the fed funds rate at about 0.9 percent at the end of 2016, compared with the median outlook of central bank officials of 1.375 percent.
Financial-market volatility and tepid inflation helped keep bond yields low in 2015. The Fed’s preferred inflation index rose just 0.4 percent in the 12 months through November, below the central bank’s 2 percent target, and policy makers’ median projection sees that picking up to 1.6 percent in 2016.
“The market’s pricing the trajectory of rate increases below the Fed’s own forecasts in part because the central bank’s expectations involve an inflation forecast that is significantly higher than traders see,” said Thomas Simons, a money-market economist at Jefferies Group LLC in New York.
The benchmark 10-year note yield fell less than one basis point, or 0.01 percentage point, to 2.24 percent as of 5 p.m. in New York, according to Bloomberg Bond Trader data. The 2.25 percent note due in November 2025 rose 2/32, or 63 cents per $1,000 face amount, to 100 4/32.
The difference between yields on government debt and similar-maturity Treasury Inflation Protected Securities, known as the break-even rate, shows traders are pricing in a sub-2 percent U.S. inflation rate for the next 30 years.
“The market’s forecasts assume the fall in commodities, especially oil, is not going to turn around anytime soon, while the Fed continually characterizes the weakness in energy prices as transitory,” Simons said.
The Fed on Wednesday will release minutes from its Dec. 15-16 meeting, at which officials lifted rates for the first time since 2006. Traders may get more insights into policy makers’ thinking on what drivers are key for subsequent rate increases. Chair Janet Yellen reiterated at a press conference after the meeting that tightening would happen gradually, but “future policy actions will obviously depend on how the economy evolves.”
The minutes may provide a “potential hawkish shock for the market,” given that they may show officials’ emphasis on the positive elements for U.S. economic growth, Aaron Kohli, a fixed-income strategist in New York for BMO Capital Markets, wrote in a note to clients Tuesday.
San Francisco Fed President John Williams said Monday that he sees three to five increases this year if the economy stays on his projected track.