U.S. Two-Year Yields Touch Highest Since June on Services Gain

  • Traders boost wagers on 2016 Fed hike as ISM gauge surges
  • JPMorgan, Goldman Sachs see 10-year yield rising to 2%

I'm a Bond Guy, We're Always Worried: Ken Monaghan

Treasuries fell, with two-year note yields touching the highest since June, after a report showed U.S. services companies expanded in September at the fastest pace in almost a year, bolstering the Federal Reserve’s case to raise interest rates.

Yields rose for a fourth day across maturities as futures traders lifted the probability of a 2016 Fed hike to the highest since August. A gauge of the yield curve flattened after the Institute for Supply Management’s non-manufacturing index jumped last month to the highest since October 2015, after a slump in August.

“You can see the reaction on an intraday basis right after the release -- the big increase in rates and the flattening in the curve -- both consistent with the repricing of the Fed,” said Priya Misra, head of global interest-rate strategy in New York at TD Securities (USA) LLC, one of 23 primary dealers that trade with the central bank. “The non-manufacturing data is a more important indicator because we are largely a service economy. It’s telling you that the momentum in the third quarter is solid.”

Investors are weighing economic data against actions of global central banks for clues about the path of U.S. interest rates. Treasuries fell Tuesday in sympathy with German bunds after a Bloomberg report said the European Central Bank will gradually wind down bond purchases before the conclusion of its quantitative-easing program. Several Fed officials in the past week have talked up the possibility of a rate increase as soon as the central bank’s November meeting.

Yields on two-year notes, the coupon maturity most sensitive to Fed policy expectations, rose one basis point, or 0.01 percentage point, to 0.83 percent as of 5 p.m. in New York, according to Bloomberg Bond Trader data, the highest closing level since Aug. 26. It touched 0.85 percent, the highest on an intraday basis since June 3. The price of the 0.75 percent note due September 2018 was 99 27/32. 

The benchmark 10-year Treasury note yield rose two basis points to 1.7 percent.

Traders assign about a 64 percent probability of a hike by year-end and a 24 percent chance of a boost at the Fed’s meeting next month, according to futures data compiled by Bloomberg. The calculation is based on the assumption the effective fed funds rate will trade at the middle of the new range after the central bank’s next boost.

JPMorgan Chase & Co. says the benchmark Treasury yield can climb as high as 2 percent this year, joining Goldman Sachs Group Inc. in predicting a level unseen since January.

“An improved growth outlook continues to bolster an outlook for higher interest rates in the fourth quarter,” JPMorgan strategists led by Jay Barry in New York wrote in a client note dated Oct. 4. “We think the 10-year yield can stretch as far as 2 percent.”

The benchmark yield dipped to a record-low 1.318 percent on July 6, when the market-implied odds of higher U.S. rates by December stood at just 12 percent.

The Federal Open Market Committee left its benchmark rate unchanged last month, noting the case for an increase had strengthened and describing risks to the economic outlook as “roughly balanced.”

The U.S. probably added 174,000 jobs in September, according to the median estimate in a Bloomberg survey of economists, up from 151,000 the month before.

Like JPMorgan, economists at Goldman Sachs see benchmark Treasury yields climbing to 2 percent by year-end, fueled by an improving outlook for inflation and economic growth. Faster inflation hurts the value of bonds’ fixed payments.

The weighted average forecast of analysts in data compiled by Bloomberg is for the yield on the benchmark note to end the year at 1.74 percent.

“All of the signals are suggesting that we are now pretty close to full employment, and we’re starting to exert some upward pressure on inflation,” Jan Hatzius, chief economist at Goldman Sachs in New York, said in a Sept. 27 interview with Bloomberg Television. “The Fed is going to respond to that. Gradually, but I think they will respond.”

The gap between yields on five- and 30-year debt, a gauge of the yield curve, flattened to about 1.18 percentage points.

— With assistance by Kevin Buckland

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