Treasuries Yield Curve Flattens as Factory Gains Boost Fed Views

  • Gap between two-, 10-year note yields narrowest since 2007
  • Futures traders see 22% chance of June interest-rate increase

Fed: U.S. Economy Growing at Modest Pace

Short-dated Treasuries fell, underperforming longer-maturity debt, as a report showing the U.S. manufacturing sector grew more than forecast last month bolstered speculation that the Federal Reserve is poised to raise interest rates.

Benchmark 10-year notes pared gains after the Institute for Supply Management’s index showed manufacturing unexpectedly expanded at a faster pace in May. A separate Fed report showed the U.S. economy expanded at a modest pace across most of the country since mid-April. The gap between yields on two- and 10-year notes, a measure of the yield curve, flattened to the narrowest since 2007 on a closing basis.

Two-year notes, which are more sensitive to Fed policy expectations, fell last month by the most since December as traders added to bets that officials will raise interest rates as soon as their June 14-15 meeting. Longer-dated U.S. debt has been supported by a tepid global economic outlook and investors deterred by low and negative bond yields abroad. Wednesday’s ISM data came after reports a day earlier showed unexpected declines in Chicago-area manufacturing and consumer confidence.

The ISM report was "better than expectations, and most people were looking for it to dip,” said Thomas Roth, senior Treasury trader in New York at Mitsubishi UFJ Securities USA Inc. “It’s one more thing the Fed can tick off as showing a rebound into the second quarter."

Beige Book

Two-year note yields rose two basis points, or 0.02 percentage point, to 0.90 percent as of 5 p.m. in New York, according to Bloomberg Bond Trader data. The price of the 0.875 percent security due in May 2018 fell 1/32, or 31 cents per $1,000 face amount, to 99 30/32.

The 10-year note yield declined one basis point to 1.84 percent, after falling as low as 1.8 percent. The 30-year bond yield fell three basis points to 2.62 percent.

The Institute for Supply Management’s index climbed to 51.3 from 50.8 in April, figures from the Tempe, Arizona-based group showed Wednesday. The median forecast in a Bloomberg survey of 81 economists called for 50.3. Readings greater than 50 indicate growth. 

Employers across the U.S. continued adding jobs and nudging wages higher since mid-April, according to the Fed’s latest Beige Book, an economic survey published eight times a year.

Yield Curve

The market-implied probability of a June Fed rate increase was 22 percent, according to futures data compiled by Bloomberg, rising to about 53 percent for a move by July. The calculation assumes the effective fed funds rate will average 0.625 percent after the central bank’s next increase.

"Officials would like rates to normalize," Guy Lebas, chief fixed-income strategist at Janney Montgomery Scott LLC in Philadelphia, said in an interview on Bloomberg Television. Rates will rise "at a snail’s pace," he said.

Traders’ expectations for a rate hike rose last week after Fed Chair Janet Yellen said the central bank will raise rates "probably in the coming months."

The gap between two- and 10-year yields narrowed to 93 basis points, after earlier touching 92 basis points. The yield curve, which plots the rates of bonds with different maturities, typically flattens when yields on shorter-maturity notes and longer-dated debt converge.

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