September Rate Increase? Bond Investors Doubt Fed Will Tip Its Hand Wednesday

        By Min Zeng
        Many bond investors are skeptical that the Federal Reserve will clearly signal a September rate increase at the conclusion of the central bank's policy meeting on Wednesday.
        Fed Chairwoman Janet Yellen said earlier this month that the central bank was on course to raise the short-term benchmark interest rate this year amid expectations that U.S. growth will gain momentum. But many fund managers say the Fed's plan to increase rates could be postponed by heightened uncertainty about the global economy, spurred by turmoil in China's stock market and a renewed selloff in commodities.
        Ultralow interest rates since the 2008 financial crisis have stoked a rally in the $12.7 trillion market for U.S. government bonds and other credit markets. Many investors are concerned that the start of a tightening cycle will send bond prices lower and yields higher. Higher rates make interest rates on existing bonds relatively unattractive.
        The yield on the benchmark 10-year Treasury note has fallen in July after posting the biggest quarterly rise in two years last quarter. The yield rose slightly to 2.252% late Tuesday as global stocks stabilized following a selloff. It was down from 2.48% made on June 26, which was the highest closing level since September. Yields fall as prices rise.
        Helping to drive yields lower are investors shifting expectations to a December rate increase. A flare-up of the Greek debt crisis, jitters about China and concern about what softening commodities markets mean for global growth also whetted investors' appetite for haven Treasurys.
        "In my opinion it is too soon to signal a hike," said Jim Caron, global fixed-income portfolio manager at Morgan Stanley Investment Management, with $406 billion in assets under management at the end of March. "The risk is the Fed hikes prematurely and hurts the economy. Why not wait until December? What's the harm?"
        The yield on the 10-year Treasury is a benchmark against which long-term rates for consumers and businesses are set. Foreign governments and firms use the 10-year yield to price their dollar-denominated bond sales.
        Many investors and interest-rate strategists say that the current bout of growth worries could prompt the Fed to stick to its script: The central bank is on track to raise rates this year but the timing of the first rate increase hinges on how the U.S. economy performs.
        "The odds are roughly 50/50 that they will raise rates in September, though the chances appear to be falling, not rising," said Kevin Giddis, head of fixed income at Raymond James in Memphis, Tenn.
        Fed-funds futures, used by investors and traders to place bets on central-bank policy, showed Tuesday that investors and traders see a 19% likelihood of a rate increase at the September Fed meeting, according to data from the CME Group. The odds for December were 54%.
        Some analysts say accelerating U.S. growth supports the case for a departure from crisis-era stimulus measures soon. Any signal from the Fed in its Wednesday statement that it was leaning toward "liftoff" in September could send bond yields higher, these analysts said. A post-Fed meeting press conference isn't scheduled.
        "I would put very high odds on a September move, as I believe that Fed officials have finally recognized that they have long overstayed their welcome at zero and are eager to begin the normalization process," said Stephen Stanley, chief economist at Amherst Pierpont Securities. "Yellen made the point in her recent Congressional testimony that starting sooner will give the Fed a better chance to be able to execute normalization at the gradual pace that she would prefer."
        Economists expect data later this week to show that the U.S. economy grew at an annualized 2.7% rate in the second quarter, rebounding from a 0.2% contraction in the first quarter.
        The Fed "is likely going through the process of assessing the potential impact of a slowdown in China to the U.S. economy," said Sean Simko, head of fixed-income management at SEI Investments which has $258 billion assets under management.
        In the meantime, lower commodities prices are hurting countries relying on raw-materials exports and reducing U.S. inflation expectations. A higher dollar driven by the prospect of the Fed's higher interest rates hurts U.S. exports and reduces prices of imported goods.
        Many investors have been long prepared for the Fed's pending shift. They have been migrating away from shorter-dated Treasurys whose yields are pinned by the Fed's short-term policy rate. Known as the fed funds rate, the Fed has held it near zero since December 2008.
        The yield on the two-year note was 0.670% Tuesday, close to 0.733% from June 10, the highest closing level in 2015.
        Investors say the preference for longer-dated bonds reflect some concerns that even a modest rate increase by the Fed may restrict the U.S. economic growth and keep a lid on inflation.
        "Yellen has said, 'Everybody wake up, we are going to move this year,' but the Fed doesn't want to choke off growth," said Donald Ellenberger, head of multisector strategies at Federated Investors Inc., which had $355.8 billion in assets under management as of March 31.
        (END) Dow Jones Newswires

        July 28, 2015 17:36 ET (21:36 GMT)

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