Treasuries Little Changed as Investors Consider Fed Exit Plans

Washington (Aug 4)  Treasuries were little changed after rallying at the end of last week as investors considered how quickly the Federal Reserve will withdraw monetary stimulus amid an uneven economic recovery.

A gauge of Treasury market volatility was at a four-month high after the Labor Department’s monthly jobs report fell short of the gains economists projected and equities tumbled amid sanctions on Russia and violence in the Middle East. Fed Bank of Richmond President Jeffrey Lacker said investors may be underestimating the pace at which U.S. officials will raise interest rates over the next two years.

“The market still seems cautious about the recovery and the jobs reports did not deliver the knock-out blow that some may have expected,” said Orlando Green, a fixed-income strategist at Credit Agricole SA’s corporate and investment banking unit in London. Treasuries are at “expensive levels when considering fundamentals. There is potential for Treasuries to ease lower.”

The U.S. 10-year yield was little changed at 2.50 percent at 7:33 a.m. New York time, according to Bloomberg Bond Trader data. The price of the 2.5 percent note maturing in May 2024 was at 100 cents on the dollar.

The index measuring 10-day price swings rose to 3.8 on Aug. 1, a level not seen since March 25. Volatility had waned in 2014, with the index averaging 3.1, compared with 4.6 during the previous five years.

Volatility Risk

Treasury market volatility increased as traders responded to unrest in Ukraine and Gaza as well as the outlook for the U.S. economy. Ten-year yields dropped seven basis points on Aug. 1, the biggest decline in two weeks, leaving the rate three basis points higher for the week.

“There’s more uncertainty in the world,” said Ali Jalai, a bond trader in Singapore at Scotiabank, a unit of Bank of Nova Scotia, one of 22 primary dealers that trade directly with the Federal Reserve. “There’s a bit more volatility.”

Short-term interest-rate markets have priced in a slower tempo of increases than Fed policy makers have forecast, a misalignment that could lead to more volatility if traders have to adjust rapidly, Lacker, who votes on policy next year, said in an Aug. 1 interview.

“When there is that kind of gap, it gets your attention,” Lacker said. “It wouldn’t be good for it to be closed with great rapidity.”

Exit Shorts

Standard & Poor’s 500 Index futures climbed 0.4 percent today after the index tumbled 2.7 percent last week, the biggest loss in two years.

“The market may depend on the stock market where we’ve seen some risk-off move in the past days,” said Allan von Mehren, chief analyst at Danske Bank A/S in Copenhagen. Stocks and Treasuries may stabilize today, he said. “We are probably bottoming in yields but the move higher will take some time and be gradual.”

The 10-year rate will be at 3 percent in six months, he said.

Investors should get out of shorts, or bets that prices will fall, according to an Aug. 1 report by New York-based JPMorgan Chase & Co., another primary dealer.

“For the next few weeks, the rate markets seem set to shift back into their low-volatility mode, leading us to turn neutral on Treasuries for the time being and to unwind tactical shorts,” Alex Roever and Kimberly L. Harano wrote in the report. “However, we continue to think longer-term Treasury yields are headed higher before year-end.”

Yields will rise as the economy grows and the Fed ends the bond purchases it has used to support the economy, according to the report.

Ten-year rates will climb to 3.11 percent by Dec. 31, according to a Bloomberg survey of economists, with the most recent forecasts given the heaviest weightings.

Source: Washington