Goldman’s Khanna Says Treasuries Risk Selloff as Fed Views Shift

  • Futures prices still lag officials’ projected rate-hike pace
  • Gap between yields on 5-, 30-year debt narrowest since March

Mapping Out the Fed's Next Moves

There’s more room for Treasuries traders to ramp up bets on how quickly the Federal Reserve will raise interest rates, and that puts bonds at risk, according to a strategist at Goldman Sachs Group Inc.

After gaining 3 percent this year, Treasuries are susceptible to “rapid repricing” due to the gap between traders’ views on rate increases this year and the Fed’s forecasts, according to Goldman. Minutes from the Fed’s April policy meeting released last week suggested an increase is possible as soon as next month, sending bond yields surging. Traders boosted the market-implied probability of a June hike to 32 percent from 4 percent a week ago.

Source: Bloomberg

“While the market has substantially repriced an increased probability of a Fed funds hike in the upcoming meetings, there is a still a significant distance to be covered for it to be in sync with the Fed’s dot-plot for the rest of 2016,” Rohan Khanna, an interest-rates strategist with Goldman in London, wrote in a note. “This implies that ‘expensive’ bonds are clearly vulnerable to a repricing.”

Policy makers have been talking up the possibility of a rate increase in the next few months after officials in March cut their forecasts for the number of hikes in 2016 to two from four. San Francisco Fed President John Williams on Monday said he sees two or three rate increases in 2016, adding to a chorus of recent voices suggesting the Fed may move as soon as next month and follow with additional increases this year.

Yield Curve

Benchmark Treasury 10-year note yields were little changed at 1.84 percent as of 5 p.m. in New York, according to Bloomberg Bond Trader data. The price of the 1.625 percent security due in May 2026 was 98 2/32. The yield on the two-year note rose 0.02 percentage point to 0.9 percent, the highest since March 15 on a closing basis.

With traders and officials still differing on the expected pace of increases over the next two years, there could be “a problem in the market” if policy makers push too hawkish a tone, Krishna Memani, chief investment officer at OppenheimerFunds, said in an interview on Bloomberg Television.

The difference between yields on five- and 30-year debt, a measure of the yield curve, narrowed for the ninth day in the past 10 to its flattest on a closing basis since March 15. Shorter-dated notes tend to be more vulnerable to policy changes, while longer-dated debt responds more to expectations for inflation and economic growth.

The yield-curve flattening in response to Fed rhetoric and the meeting minutes is prone to “at least a partial reversal” over the next one to two months, UBS Ltd. strategists including Justin Knight and Matthias Rusinski wrote in a May 22 note.

“We think that implicit barriers to an imminent hike remain high, and see a move before September as unlikely,” the analysts wrote.

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