U.S. Two-Year Notes Post Worst Month Since December on Fed Bets

  • Futures traders see 24% chance of June interest-rate increase
  • Economic data surpassing forecasts, Bloomberg index shows

Treasury two-year notes recorded their worst monthly performance since December, when the Federal Reserve raised interest rates for the first time in nearly a decade, as traders weigh whether policy makers may hike again as soon as next month.

Yields on two-year notes, the coupon securities most sensitive to Fed policy expectations, retreated after touching the highest since March as a report showed personal spending exceeded forecasts in April. Economic data are surpassing analysts’ estimates by almost the most since January 2015, based on the Bloomberg ECO U.S. Surprise Index.

Throughout May, officials underscored the Fed’s intent to raise rates in 2016, perhaps more than once and as soon as June. Fed Chair Janet Yellen in an appearance May 27 said policy makers would look to boost borrowing costs in the “coming months.” Futures traders assign a 24 percent probability the central bank will hike at its June 14-15 review, up from 4 percent three weeks ago, and a 74 percent chance of a hike by year-end. 

“Over the medium term, the greatest risk factor is monetary-policy exhaustion,” Kristina Hooper, U.S. investment strategist at Allianz Global Investors in New York, said in an interview on Bloomberg Television. “We’re getting close, and that seems to be one of the reasons the Fed is talking up the possibility of a June or July rate hike. They really do want to have some powder dry if things go south at some point with the economy.”

Yields Retreat

The two-year note yield fell three basis points, or 0.03 percentage point, to 0.88 percent as of 5 p.m. in New York, according to Bloomberg Bond Trader data, after touching the highest in more than two months. It rose 10 basis points in May, the biggest climb since December. The price of the 0.875 percent security due in May 2018 was 100.

Benchmark 10-year notes erased losses, with yields little changed at 1.85 percent. The yield rose one basis point in May.

Bonds rallied as stocks declined and after a poll showed a jump in support for the campaign to take Britain out of the European Union, spooking some investors who had thought that the result was a foregone conclusion.

“We are off the yield highs because in the U.S. session we have gained a bit of a risk-off feel,” said John Briggs, head of strategy for the Americas in Stamford, Connecticut, at RBS Securities Inc., one of the 23 primary dealers with the Fed. A British exit would “be bad for risk and good for flight to quality due to increased uncertainty.”

Traders have been parsing data for signs the U.S. economy can withstand higher borrowing costs. Treasuries benefited from unexpected declines in Chicago-area manufacturing and consumer confidence, even as consumer purchases increased more than forecast and a key measure of inflation rose by the most since May 2015.

“The market’s debating what it will take to cement a rate hike in June or derail the prospects for action at the next meeting,” David Ader and Ian Lyngen, strategists at CRT Capital Group LLC in Stamford, Connecticut, wrote. “We’re open to the argument however that the Fed has been so effective in convincing the market to price in a reasonable probability of a move this summer that this fact alone increases the chances they actually pull the trigger.”

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