Bond Traders Clear a Path for Fed to Lift Interest Rates in June

by Alexandra Scaggs Anooja Debnath

The bond market is boosting its bets on a Federal Reserve interest-rate increase in June as stocks and oil rally.

As Treasuries head toward a third straight weekly decline, traders now see the probability of a June rate hike as slightly better than coin flip, according to futures data compiled by Bloomberg. That’s up from a 45 percent chance assigned Thursday and odds below 10 percent seen a month ago. Since 1994, the Fed hasn’t raised rates unless the futures market had priced in at least 60 percent of the move the day before, Bank of America interest-rate strategist Mark Cabana wrote in a March 11 note.

“It seems like the market is within in the range” that “the Fed would be comfortable with” for a June increase, Cabana said by phone from New York.

There’s almost no market expectation for the Fed to raise rates at its next policy-setting meeting March 15-16, with the futures market implying a 4 percent chance, assuming the fed funds effective rate averages 0.625 percent after the next hike. For the central bank’s June meeting, though, the market-implied probability rose to 51 percent Friday as gains in stocks and crude prices dented demand for Treasuries and other havens.

Benchmark 10-year note yields rose five basis points, or 0.05 percentage point, to 1.98 percent as of 12:47 p.m. New York time, according to Bloomberg Bond Trader data, the highest on an intraday basis since Jan. 29. The price of the 1.625 percent security due in February 2026 fell 14/32, or $4.38 per $1,000 face amount, to 96 26/32.

A equities rally Friday helped the Bloomberg U.S. Financial Conditions Index, which tracks financial-market stress, turn positive for the first time this year.

The Bank of America analysts found that the amount of Fed tightening has been “closely linked” to financial conditions since the start of 2015, and the market seems to have noticed. On Feb. 11, the 2016 low for stocks, Treasury yields and the Bloomberg Financial Conditions Index, the futures-implied probability of a Fed hike this year was 11 percent. By Friday, the probability had climbed to 78 percent. That might pose a challenge for both traders and U.S. central-bank officials, said Cabana.

“At some point, they’re going to want to break that link, and that could be a surprise to the market and put them in a bit of a tight spot,” he said.

Economic Data

Improving U.S. economic data in recent weeks have boosted the outlook for inflation and economic growth. Citigroup’s Economic Surprise Index for the U.S., which measures the strength of data relative to analysts forecasts, climbed to minus 9.8 Thursday, the highest closing level since November. While still below zero, which shows data releases have been undershooting predictions, the gauge has risen from an eight-month low of minus 55.7 reached on Feb. 4.

As data and financial conditions improve, Treasuries (TLT) have been the worst performers after Canadian bonds in the past month among global sovereign debt, based on Bloomberg World Bond Indexes, which track 26 nations. U.S. debt has lost 1.2 percent, and Canadian debt has handed investors a 1.7 percent loss.

Even so, more losses could be in store, according to Mark Kiesel, chief investment officer for global credit at Pacific Investment Management Co. He said the market is still underrating U.S. economic strength and the Fed’s path.

“The market may be underestimating the fact that the U.S. economy is doing pretty well, and that the Fed is probably going to go this year,” he said in an interview on Bloomberg Television Friday.

Courtesy of bloomberg.com