Treasury Two-Year Notes Fall as Fed Officials Hint at Rate Hikes

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  • Williams, Lockhart say two or three increases possible in 2016
  • Futures traders add to bets that Fed will tighten policy

What Will the April FOMC Minutes Reveal?

Two-year notes fell by the most in more than two months as comments by Federal Reserve officials and gains in inflation bolstered speculation the central bank will raise interest rates this year.

Yields rose as San Francisco Fed President John Williams and Atlanta Fed President Dennis Lockhart said two or three rate increases are possible in 2016, and after data showed the cost of living in the U.S. climbed by the most in three years. Traders added to wagers that the Fed will lift interest rates as soon as next month, even as the futures market isn’t fully pricing in the next increase until 2017.

Signs of strength in the world’s biggest economy are lending credence to policy makers’ forecasts of two rate increases this year after the Fed lifted its benchmark from near zero in December. Both Lockhart and Williams, who aren’t voting members of the policy-setting Federal Open Market Committee this year, said the central bank’s next meeting in June is still in play for a rate increase, according to remarks Tuesday on a panel in Washington.

"The Fed is trying to tell the market it’s mispriced," said Charles Comiskey, head of Treasury trading in New York at Bank of Nova Scotia, one of the 23 primary dealers that trade with the central bank. "The Fedspeak is pounding into the head of the market that June is live and they could move. If that’s the case, the bond market is completely wrong."

The yield on the two-year note, the coupon security most sensitive to expectations for Fed policy, rose four basis points, or 0.04 percentage point, to 0.83 percent as of 5 p.m. in New York, the the biggest rise since March 1, according to Bloomberg Bond Trader data. The price of the 0.75 percent security due April 2018 was 99 27/32.

The yield on the benchmark 10-year note rose two basis points to 1.77 percent.

Rate Bets

Lockhart said wages and prices are moving toward the Fed’s goal, while Williams said the U.S. is at or very close to full employment. The FOMC releases minutes of its April policy meeting on Wednesday.

“We’re seeing a little bit of a pullback in the front end just to price in a little bit more of a possibility of hawkish minutes, or maybe just not dovish minutes,” said John Briggs, head of strategy for the Americas at RBS Securities Inc. in Stamford, Connecticut, a primary dealer.

The market-implied probability of a rate increase in June is 12 percent, up from 4 percent Monday, according to futures data compiled by Bloomberg. It rises to about 65 percent for a move by year-end, up from 56 percent a day earlier. The calculation assumes the effective fed funds rate will average 0.625 percent after the central bank’s next increase.

U.S. consumer prices increased 0.4 percent in April, the most since February 2013, compared with the median projection of a 0.3 percent advance, a Labor Department report showed Tuesday. A separate report showed industrial production climbed 0.7 percent.

The inflation figure is “a pretty solid number, and it may well be the first step, or one of the steps, in that long road towards still a potential summer rate hike," Ebrahim Rahbari, an economist at Citigroup Inc. in New York, said in an interview on Bloomberg Television. "It reinforces the idea that inflation is normalizing, and so should interest rates, perhaps."