Bond Traders' Confidence in Fed Path Weakens After Chaotic Week

  • Probability of interest-rate increase by March dwindles
  • Ten-year Treasuries post biggest weekly gain since October

Treasuries surged to start the year as turmoil in China’s financial markets damped global risk appetite and emboldened bets that the Federal Reserve will fail to lift interest rates in 2016 as much as policy makers envision.

In the eyes of traders, the probability that the Fed will boost its benchmark rate again by March slid this week, even as a report showed U.S. job creation surged in December. Losses in global stocks and tumbling oil prices signaled dimming prospects for economic growth and inflation and boosted demand for U.S. government debt as a haven.

Across maturities, yields are back below levels from before the Fed’s Dec. 16 decision to raise its overnight target from near zero, where it’d been since 2008. The strength in bonds runs counter to Wall Street’s consensus call for higher yields this year and shows traders’ skepticism about Fed forecasts of four rate increases in the next 12 months.

“The market only believes the Fed can go once or twice before growth becomes affected in a negative way,” Bill Gross, the Newport Beach, California-based lead manager of the $1.3 billion Janus Global Unconstrained Bond Fund, said in a Bloomberg TV interview.

The yield on the benchmark 10-year Treasury note fell 15 basis points, or 0.15 percentage point, this week, the most since early October, to 2.12 percent, according to Bloomberg Bond Trader data. The price of the 2.25 percent security maturing in November 2025 rose 1 11/32, or $13.44 per $1,000 face amount, to 101 5/32.

Shrinking Cushion

The gains drove 10-year yields down to about 1.18 percentage points above two-year yields, the smallest difference since July 2012.

The bond advance came to a brief halt Friday after government data showed U.S. employers added 292,000 jobs last month, compared with 252,000 in November. The tally exceeded the highest estimate in a Bloomberg survey. Treasuries bulls found reason to cheer from the data as average hourly earnings increased less than forecast, evidence that employment strength isn’t generating quicker inflation.

Traders assign about a 40 percent probability that the next rate increase will come at the March policy meeting, down from a 56 percent chance seen at the end of last month. Over the course of 2016, derivatives traders see about two Fed rate increases.

January Gain

U.S. government debt is up 0.9 percent this year, according to Bloomberg total return indexes.

Investors bought ahead of auctions next week of a combined $58 billion of coupon-bearing Treasuries, including three-, 10- and 30-year obligations.

The market tumult originated in China, the biggest foreign holder of Treasuries, whose currency cheapened this week by the most since August amid signs the world’s second-biggest economy is cooling. Oil dropped to a 12-year low.

Treasuries drew support “given the global issues and fears as we got lower-than-expected average hourly earnings, which gives people a little pause with respect to potential inflation,” said Dan Mulholland, head of Treasuries trading in New York at Credit Agricole SA. “That pushed the Fed timing out a bit. All these things, with new lows in oil, create a dovish scenario.”

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