Treasuries Surge as Investors Seek Refuge, Fed Rate Path Doubted

  • U.S. government bonds gain 1.6% in 2016 amid global stock rout
  • Traders curb wagers on inflation as oil price plunges

A dimming outlook for inflation and global economic growth pulled Treasury yields lower for a second week amid a stock-market rout and plunging oil prices, as traders push back the anticipated timing for Federal Reserve interest-rate increases.

Benchmark 10-year yields dipped below 2 percent Friday for the first time since October while yields on 30-year bonds, the maturity most sensitive to inflation, closed at the lowest since August. The yield on the two-year note, which is most influenced by Fed policy expectations, fell for a 12th straight trading day.

Treasuries have benefited as global equities endured the worst start to a year on record and oil prices dropped to a 12-year low. A bond-market gauge of the inflation outlook over the next decade, known as the 10-year break-even rate, fell to the lowest since September, as traders reduced wagers on how soon and how often the Fed will raise rates this year.

"Both the huge decline in equities and oil are psychological catalysts and force investors to reassess their outlook," said Gary Pollack, who manages $12 billion as head of fixed-income trading at Deutsche Bank AG’s Private Wealth Management unit in New York. "As a result they embrace bonds. These types of moves have to give the Fed pause before they move again."

The benchmark Treasury 10-year note yield declined eight basis points in the week, or 0.08 percentage point, to 2.04 percent as of 5 p.m. New York time, according to Bloomberg Bond Trader data. It touched 1.98 percent on Friday, the lowest since Oct. 15. The 2.25 percent security due in November 2025 rose 23/32, or $7.19 per $1,000 face amount, to 101 29/32.

‘Sick’ Economy

The yield on the two-year note dropped eight basis points this week to 0.85 percent, the lowest since Nov. 13 and down 20 basis points since the start of the year.

Treasuries maturing in more than a year have earned a total return of about 1.6 percent in January, after returning 0.9 percent in 2015, Bloomberg bond indexes show. In comparison, the Standard & Poor’s 500 index of shares has lost about 8 percent in 2016, including reinvested dividends.

"These oil markets and equity markets are telling us that the global economy is quite sick," said Steven Major, head of fixed-income research at HSBC Holdings Plc, in an interview on Bloomberg Television. "What’s happening to commodities is just validating where bond yields are going."

Policy Expectations

Futures traders assign about a 28 percent chance that the Fed will boost borrowing costs in March, based on the assumption that the effective fed funds rate will trade at the middle of the new target range after the next increase. That implied probability rose as high as 53 percent on Dec. 30, following the Fed’s Dec. 16 decision to boost borrowing costs for the first time in nearly a decade.

The U.S. economy should continue to grow faster than its potential this year, supporting further interest-rate increases, New York Fed President William C. Dudley said in remarks prepared for a speech Friday in Somerset, New Jersey. “In terms of the economic outlook, the situation does not appear to have changed much” since the Fed’s Dec. 15-16 meeting, Dudley said.

The Fed expects to raise rates four times this year, which would bring the effective rate to 1.375 percent, according to the median forecast among Federal Open Market Committee members.

Derivatives traders expect the effective fed funds rate will rise to about 0.7 percent in a year’s time, implying one increase this year, according to data compiled by Bloomberg. As of Dec. 30, they were betting borrowing costs would rise to 0.93 percent, which would require the Fed to lift rates twice, assuming it raised its target range by 0.25 percentage point each time.

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