Bond Traders Slow to Sell on Jobs Surge in Face of Patient Fed

  • Chance of U.S. interest-rate hike in September just 26 percent
  • ‘Market has seen this movie before,’ Simons at Jefferies says

The Federal Reserve’s patience is rubbing off on bond traders.

Treasuries fell Friday after Labor Department data showed U.S. hiring surged in July. Still, yields on two-year notes, the securities most sensitive to Fed policy expectations, closed below levels reached less than two weeks earlier.

The subdued selloff following a second-straight robust payrolls report signals traders remain reluctant to push the sell button after the Fed -- which entered 2016 expecting to raise interest rates four times -- has held off on hiking time and time again. The implied probability of a rate boost in September is just 26 percent, and futures indicate officials are more likely to do nothing for the remainder of the year than to move.

“The market has seen this movie before -- it takes a long time to build momentum and no time to destroy it,” said Thomas Simons, senior money-market economist at Jefferies LLC in New York.

Fed Outlook

Two-year note yields rose seven basis points last week, or 0.07 percentage point, to 0.72 percent at 5 p.m. New York time Friday, according to Bloomberg Bond Trader data. Benchmark 10-year U.S. note yields rose 14 basis points to 1.59 percent.

Traders have rebuilt wagers on a 2016 rate increase after slashing those bets following the U.K.’s June 23 vote to leave the European Union. The Citigroup Inc. U.S. Economic Surprise Index, which measures whether data beat forecasts, touched the highest since 2014 last month before retreating after a July 29 report showed U.S. gross domestic product grew at less than half the pace economists predicted.

Fed Chair Janet Yellen will have a chance to air her views on the economy’s progress when she speaks on Aug. 26 at the Kansas City Fed’s annual policy symposium in Jackson Hole, Wyoming. Officials project one increase this year as they try to tighten policy against a tide of monetary easing worldwide. The Bank of England on Aug. 4 cut interest rates and announced other stimulus to ramp up defenses against a Brexit-induced slump.

Expanding Payrolls

Friday’s nonfarm payrolls report showed employers added 255,000 positions in July, versus a median forecast of 180,000 in a Bloomberg survey of economists. Wage growth also beat estimates, which may help sustain consumer spending into the second half of the year. The labor-force participation rate increased and the jobless rate held at 4.9 percent.

“The report is universally strong and certainly increases the chances that Yellen uses her Jackson Hole speech as an opportunity to reiterate the chances of another hike by year-end -- whether they actually follow-through is another issue entirely,” said Ian Lyngen, who along with David Ader was voted the top Treasuries strategists for 2016 in an Institutional Investor poll last month.

So what’s holding up the bond market?

“The market will need more than a couple strong NFP prints to convince it the Fed is really in play after last week’s dismal GDP and all the global easing,” Lyngen said.

Domestic Data

Not everyone is counting out the Fed. Allianz SE’s Mohamed El-Erian said traders underestimate the probability that policy makers will raise rates next month. He sees the likelihood at 40 percent to 45 percent, he said in a Bloomberg Television interview.

Meanwhile, Bill Gross, El-Erian’s former colleague at Pacific Investment Management Co., sees a September hike as less likely -- and December as just a “maybe” if better-than-expected data persist. While recent reports showed improvement in U.S. jobs, retail sales and industrial production, economic momentum abroad remains sluggish, the Janus Capital Group Inc. money manager said.

The Treasuries market will only begin to react in full when the Fed acknowledges the strength of the U.S. economy, said Jeffrey Rosenberg, chief investment strategist for fixed income at BlackRock Inc. 

The only such hint investors got last month was the statement from policy makers that “near-term risks to the economic outlook have diminished.” Officials also said they expect economic conditions “warrant only gradual increases” in the Fed’s benchmark rate.

“The market is going to need to see the rhetoric and the commentary from the Fed begin to change to acknowledge the strength and balance out the outlook for how quickly they’re going to be tightening,” Rosenberg said in an interview on Bloomberg Radio. Without that, yields are “not going to really move significantly higher,” he said.

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