Bond Market Shows Traders Aren’t Ready for Evans’s Three Hikes

  • Traders split on odds of more than one increase by end of 2017
  • Treasury 10-year yield may rise past 2.5% on three hikes: Kim

Monetary Policy Appears Close to Its Limits, Says Wilson

Federal Reserve official Charles Evans has added his voice to forecasts for up to three interest-rate increases by the end of 2017. The bond market shows traders aren’t ready for that many.

Chicago Fed President Evans joined San Francisco counterpart John Williams, who last week said he supported one rate move this year and “a few” the next. Pacific Investment Management Co. said this month U.S. rates may rise two or three times over the period. Futures contracts show traders are banking on one move, with the odds of a second one being no more than a coin flip.

“Yields already reflect one rate hike,” said Kim Youngsung, head of overseas investment in Seoul at South Korea’s Government Employees Pension Service, which has $13 billion in assets. “If you expect two hikes next year, yields will rise. We’re not sure about next year. That totally depends on the data.”

The benchmark Treasury 10-year note yield rose one basis point, or 0.01 percentage point, to 1.78 percent as of 9:32 a.m. in New York, according to Bloomberg Bond Trader data. That compares with a record low of 1.32 percent set in July. The 1.5 percent security due in August 2026 fell 3/32, or $0.94 per $1,000 face amount, to 97 17/32.

After one increase “for sure” in December, two more in 2017 will send the 10-year yield past 2.5 percent, Government Employees Pension Service’s Kim said. Economists predict the benchmark will end next year at 2.14 percent, according to a Bloomberg survey with the most recent forecasts given the heaviest weightings.

Rate Probability

Futures show a 74 percent probability the central bank will raise rates by the end of this year, according to calculations by Bloomberg that assume the effective fed funds rate will average 0.625 percent after the next increase. The probability of an additional move during 2017 is about 53 percent.

That chimes with the view of one of the world’s largest money managers, JPMorgan Asset Management, which sees the Fed hiking once per year to a rate of about 1 percent. The 10-year Treasury yield is likely to head toward 1.5 percent in the coming year, Nicholas Gartside, London-based chief investment officer for fixed-income, said in an interview in Tokyo last week. The company oversees $1.6 trillion.

For more of JPMorgan Asset Management’s views, click here.

Evans, who votes on monetary policy next year, said on Monday in Chicago if the economy keeps growing in line with his forecast, it may be appropriate to raise rates three times by the end of 2017.

Williams, who doesn’t vote on policy until 2018, said on Friday in San Francisco the economy “is well-positioned” for higher borrowing costs. Having “a rate increase this year makes sense, having a few rate increases next year makes sense, in the context of how the economy has been performing and continues to perform,” he said.

Quicker Growth

U.S. gross domestic product expanded 2.5 percent in the third quarter, the fastest pace in more than a year, according to the median estimate of economists surveyed by Bloomberg, before the data is published Friday.

Domestic growth hasn’t been the Fed’s only consideration in 2016. Concern China’s economy is slowing helped put the Fed off a potential rate increase earlier this year, and the U.K.’s vote over European Union membership weighed on its June and July meetings.

“I’m worried about a hard Brexit,” said Kei Katayama, a bond manager in Tokyo at Daiwa SB Investments, which oversees $51.7 billion. “That may push central banks to be more cautious. Two rate hikes next year may be possible. I’m not betting on it.”

The Treasury is scheduled to auction $26 billion of two-year notes Tuesday, followed by a sale of $34 billion of five-year securities Wednesday and $28 billion of seven-year debt a day later. It also plans to sell $15 billion of two-year floating-rate notes Wednesday.

The October 2018 notes due to be sold yielded 0.865 percent in pre-auction trading, compared with 0.75 percent at a two-year debt sale on Sept. 26.

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