U.S. Government Bonds Pull Back on Fed Outlook

By Min Zeng 

        U.S. Treasury bonds pulled back on Monday as a Federal Reserve official reminded investors that the central bank could start raising interest rates in September.
        Federal Reserve Bank of St. Louis President James Bullard said Monday that he sees more than 50% probability for the Fed to tighten in September.
        Mr. Bullard was the latest Fed official expressing intent to move away from zero-interest-rate policy. Fed Chairwoman Janet Yellen told lawmakers last week that the central bank was on course to tighten monetary policy later this year. Investors are concerned a shift in the ultraloose monetary policy could shrink the value of outstanding bonds.
        "The Fed does not feel compelled to wait for signs of blockbuster growth or soaring inflation to implement an initial, small rate increase," said James DeMasi, chief fixed-income strategist at Stifel Nicolaus & Co. in Baltimore.
        In recent trading, the yield on the benchmark 10-year Treasury note was 2.371%, compared with 2.349% on Friday, according to Tradeweb. Yields rise as prices fall.
        The yield on the two-year note, among the most sensitive to changes in the Fed's rate-policy outlook, was 0.702%, near the highest level of the year, compared with 0.669% on Friday.
        Corporate-debt sales also weighed down on Treasury bond prices. U.S. firms are selling debt to lock in still-low borrowing costs before the Fed raises interest rates. Firms typically sell Treasury bonds to hedge against volatility in yields when they plan to sell new debt, highlighting the U.S. government- bond market's role in corporate-debt financing.
        U.S. bond yields have risen over the past few months after a decline during the first quarter. The U.S. economy has been strengthening after a recent soft patch, reducing demand of ultrasafe U.S. government debt.
        Investors also shed holdings as a fresh tightening campaign by the Fed draws near amid concerns over bonds' elevated value boosted partly by the Fed's zero-rate policy since the financial crisis.
        Greece's sovereign-debt crisis and China's stock-market turmoil have diminished over the past week, which has shifted investors toward the Fed's tightening plan.
        "The Fed has the flexibility to raise rates this year," said Eric Stein, co-director of global income at money manager Eaton Vance Management, which has $307.3 billion in assets. "I think bond-market trading will continue to be volatile regarding the timing of the Fed to move."
        Mr. Stein has been prepared for a rise in interest rates by holding less Treasury debt compared to a benchmark bond index.
        The Fed's next policy meeting is scheduled for July 28-29.
        Many investors remain skeptical whether the Fed would raise rates as soon as September.
        Fed-funds futures, used by investors and traders to place bets on central- bank policy, showed Monday that investors and traders see a 17% likelihood of a rate increase at the September meeting, little changed from a month ago, according to data from the CME Group.
        The Fed is the only major central bank considering raising rates this year. Many central banks have cut interest rates or launched asset purchases to boost flagging growth. Analysts say such loose monetary stimulus backdrop will keep a lid on global bond yields. U.S. Treasury debt continues to offer higher yields compared with counterparts in Germany, Japan, the U.K. and France.
        Mr. DeMasi at Stifel Nicolaus says shorter-dated bond yields would rise at a faster pace as they are more sensitive to the Fed's policy outlook. He expects the two-year yield to rise to 1% at the end of this year.
        Meanwhile, Mr. DeMasi says the 10-year Treasury yield is expected to end this year at 2.5%, a level it touched briefly in June and the highest level since September.
        "The combination of a very gradual tightening campaign, moderate economic growth, and well-behaved inflation would firmly anchor long-term yields," he said.
        Write to Min Zeng at min.zeng@wsj.com
        (END) Dow Jones Newswires

        July 20, 2015 12:04 ET (16:04 GMT)

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