Treasuries Decline as Yellen Sees Gradual Path to Raising Rates

  • Fed chair says positive economic forces outweigh negatives
  • Bond traders pricing in 22% probability of July rate hike

Treasury 10-year notes fell for the first time in five days as Federal Reserve Chair Janet Yellen said positive U.S. economic developments will probably outweigh negative forces and called gradual interest-rate increases appropriate.

Benchmark yields climbed from the lowest level in three weeks as Yellen said rates “will probably need to rise gradually over time” in a speech in Philadelphia. Treasury two-year notes surged on June 3 by the most since September after data showed the U.S. added the fewest jobs in May in almost six years, pushing traders to slash bets on a rate increase in June or July.

Policy makers have stressed data dependence in determining whether the U.S. economy is strong enough to withstand higher borrowing costs. Yellen said May 27 that the central bank will raise rates "probably in the coming months," a phrase she omitted from Monday’s speech. Since the release of the May employment report, Fed speakers have cautioned patience in raising rates while determining whether the weak data were an anomaly.

“The most pertinent part of the speech is excluding the phrase ‘in the coming months’ in characterizing data dependence and the pace of tightening,”said Tim High, director of U.S. rates strategy at BNP Paribas in New York, one of the 23 primary dealers that trade with the central bank. “Seems like they suspect, like me, that any tightening will need to be deferred.”

Benchmark U.S. 10-year note yields rose four basis points, or 0.04 percentage point, to 1.74 percent as of 5 p.m. New York time, according to Bloomberg Bond Trader data. The price of the 1.625 percent security due in May 2026 was 98 31/32. The yield fell 10 basis points on June 3, the biggest decline since Feb. 2.

Traders see a 2 percent chance the Fed will raise rates by its June 14-15 meeting and a 22 percent chance of a move by July, down from respective odds of 30 percent and 54 percent as of May 27, futures contracts indicate. Only the likelihood of an increase by the Fed’s final gathering of 2016, in December, is seen as greater than 50 percent.

The May employment numbers were “disappointing,” Yellen said, while also pointing to one of the few encouraging elements of the report -- the increase in average hourly earnings.

“She is trying to de-emphasize Friday’s report somewhat and focus on the macro view that the economy remains on track, and her opinion that rates hikes will be gradual but will continue,” said Charles Comiskey, head of Treasury trading in New York at Bank of Nova Scotia, a primary dealer. “The market reaction is very small with curve taking back part of Friday’s move.”

Before it's here, it's on the Bloomberg Terminal.