Bond Traders Signal Two Rate Hikes in 2017, While Fed Sees Three

  • Futures signal 78% chance of next move coming by June
  • Dollar rises, two-year yields reach highest since 2009

Bond traders are signaling they agree with the Federal Reserve’s decision to project a steeper path of interest-rate increases. They’re just not sold on the frequency.

Officials lifted their target for overnight borrowing costs by a quarter-point to a range of 0.5 percent to 0.75 percent Wednesday, the first hike in a year. They also released a projected rate path, known as the “dot plot,” calling for three quarter-point hikes in 2017, up from the two seen in previous forecasts in September.

In the futures market, traders also added one hike to 2017 rate bets. Yet they still see only two increases in the coming year, with about a 78 percent chance the next one comes by June, based on the assumption that the effective fed funds rate will trade at the middle of the new target range after the next increase.

“If the Fed was only saying two rate hikes, the chances were the market would get there,” said Ward McCarthy, a senior economist at Jefferies. “Now three hikes increases the odds the Fed is overestimating again.” 

Traders were looking to policy makers for guidance after Donald Trump’s election victory drove the dollar to the strongest in more than a decade and yields on benchmark 10-year Treasuries to the highest since 2014.

‘Big Surprise’

"The extra dot is the big surprise,” said Andrew Chorlton, a New York-based money manager at Schroders Plc. “The risk was that if they do another hike early in the year people will start to expect more than two.”

The Treasury 10-year note yield rose seven basis points to 2.54 percent at 3:38 p.m. in New York, according to Bloomberg Bond Trader prices. The two-year yield climbed 10 basis points to 1.26 percent, reaching the highest since 2009.

The Bloomberg Dollar Spot Index gained 1.1 percent, after surging since Trump’s election amid speculation the president-elect’s policies will stoke economic growth and inflation, prompting the Fed to keep tightening. The greenback eclipsed 117 yen for the first time since February.

Hedge funds and other large speculators came into the Fed decision with a bullish stance on the dollar, after boosting net long positions to the highest since January, according to data from the U.S. Commodity Futures Trading Commission. Speculators in the world’s most actively traded money-market futures were also positioned for further rate increases.

“The market was waiting for a hawkish statement and initial reaction is consistent with that,” Bipan Rai, a senior foreign-exchange and macro strategist at Canadian Imperial Bank of Commerce in Toronto, said in an e-mail.

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