Treasury Two-Year Notes Decline as Wage Growth Boosts Fed Bets

  • Hourly earnings rise 2.5% in past year, exceeding forecasts
  • Traders lift wagers on 2016 rate increase amid inflation signs

How Will U.S. Jobs Report Impact Fed Rate Policy?

Treasury two-year notes fell as a report showing stronger U.S. wage growth in January prompted traders to boost wagers that the Federal Reserve will raise interest rates in 2016.

Yields rose after the Labor Department said the U.S. created 151,000 jobs last month, less than the 190,000 median forecast in a Bloomberg survey of economists. Average hourly earnings rose 0.5 percent from a month earlier, more than the 0.3 percent forecast. The year-over-year increase of 2.5 percent followed a 2.7 percent jump in the 12 months ended in December that was the biggest advance since mid-2009.

The report eased some concern that tumbling oil prices and a global stock-market rout are dragging down U.S. economic growth and inflation expectations. Ten-year Treasury yields touched a one-year low this week as economists and traders doubted whether the Fed will be able to carry out the four rate hikes that policy makers have targeted this year.

“The market’s attention in this report is much more about the details rather than the headline payroll number,” said Aaron Kohli, an interest-rate strategist in New York with BMO Capital Markets, one of the 22 primary dealers that trade with the Fed. “Average hourly earnings were good. Everyone has been waiting to see what wages do, and this is a good indicator.”

Yields on two-year notes, the coupon securities most sensitive to Fed policy expectations, rose two basis points, or 0.02 percentage point, to 0.72 percent as of 5 p.m. New York time, according to Bloomberg Bond Trader data. The yield fell to 0.67 percent this week, the lowest since October.

Benchmark 10-year note yields were little changed at 1.84 percent after rising as high as 1.89 percent. The yield dropped to 1.79 percent Wednesday, the lowest in a year.

Fed Chances

The U.S. central bank in December raised rates for the first time in nearly a decade. That month, officials’ median forecast called for four rate increases this year if their economic projections hold up.

Traders boosted the likelihood of a rate increase by the end of 2016 after the employment report, even as they bet the Fed will move once this year at most. Futures prices indicate the Fed’s effective rate will be 0.54 percent by year-end, up from 0.51 percent Thursday. That’s still below the 0.625 percent level where it may stand if the central bank raises its target range by a quarter-point again.

Inflation Expectations

One factor holding down market expectations for Fed rate moves is persistently low inflation. The Fed’s favored inflation measure hasn’t reached the central bank’s 2 percent target since 2012, and tumbling oil prices have pushed down gauges of bond-market inflation expectations.

“Wage pressures could start to build in the market here,” said Patrick Maldari, senior fixed-income portfolio manager in New York for Aberdeen Asset Management Inc., which manages $428 billion. Still, “we’re not big believers that we’re going to see a huge acceleration in inflation.”

The market implies a 53 percent chance the Fed will raise rates at or before its Dec. 14 meeting. That’s up from 46 percent Thursday but down from a 93 percent probability assigned at the end of last year. The calculation is based on the assumption that the effective fed funds rate will trade at the middle of the new target range after the next increase.

“If I were at the Fed I’d say overall ‘pretty good’ on the report,” said Kathy Jones, chief fixed-income strategist at Charles Schwab & Co. in New York. “I don’t think it will move them to raise rates, all else equal, anytime soon but it keeps it in play, which is something the market really hadn’t thought was possible a day or two ago. The market got a little too pessimistic on the timing.”

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