Treasuries Stumble as Fed Rate Increase Odds Above 50%

  • New York Fed’s Dudley says September rate increase possible
  • Bonds have been on best run since 2011 as Fed seen on hold

The Factors Adding Selling Pressure on the Dollar

William Dudley is giving Treasuries investors pause after the best run of any year since 2011.

U.S. sovereign debt held a two-day decline Wednesday, a day after the Federal Reserve Bank of New York president said the bond market looked “a little bit stretched,” and an interest-rate increase could come as soon as next month. Futures traders raised bets for tighter policy in 2016 above 50 percent for the first time since just before the U.K. voted to leave the European Union.

Mixed domestic data coupled with signs of slowing growth abroad have stayed the Fed’s hand this year, emboldening bond bulls. After liftoff from near zero in December, officials have twice cut their projections for the path of hikes. A JPMorgan Chase & Co. survey showed Treasury investors held the most net long positions since June 20 in the week ended August 15.

“Benchmark 10-year yields around 1.5 percent show the market isn’t concerned about higher rates, and Dudley doesn’t want that situation,” said Kazuaki Oh’E, the head of fixed income at CIBC World Markets Japan Inc. in Tokyo. “The Fed wants to prepare the market for the next hike.”

The Treasury 10-year yield was little changed at 1.58 percent as of 9:51 a.m. in London, a six basis-point increase this week, according to Bloomberg Bond Trader data. The price of the 1.5 percent security due in August 2026 was 99 10/32. The yield dropped to a record 1.318 percent last month.

Trading Strategy

Oh’E recommends taking profit on 10-year notes when yields reach 1.5 percent, and adding to positions when they are at or above 1.6 percent.

The Bloomberg U.S. Treasury Bond Index has climbed 5.1 percent since the end of December, the most over the period of any year since a surge of more than 6 percent in 2011. The gauge finished that year with an almost 10 percent advance.

Dudley, who serves as vice chairman of the rate-setting Federal Open Market Committee, said on Fox Business Network that policy makers are “edging closer towards the point in time where it will be appropriate, I think, to raise interest rates further.”

Investors will look to the release on Wednesday of minutes from the FOMC’s July meeting for further insight into officials’ latest thinking. Policy makers left rates unchanged last month, but said in a statement that “near-term risks to the economic outlook have diminished.”

Fed funds futures implied 51 percent odds for a rate rise by year-end, compared with 42 percent at the end of last week, according to Bloomberg calculations.

“Dudley definitely had an impact on the market,” said Justin Lederer, an interest-rate strategist at Cantor Fitzgerald LP in New York, one of the 23 primary dealers that trade with the Fed. “The market’s still not pricing it in,” Lederer said of a 2016 hike, “but the truth is a lot of people are expecting it.”

(Corrects characterization of projected Fed rate path in third paragraph of story published Aug. 17.)
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