Federal Reserve

Fed rate increase a certainty for bond traders as market odds hit 100 per cent

PUBLISHED : Wednesday, 23 November, 2016, 3:50am
UPDATED : Wednesday, 23 November, 2016, 3:50am

A Federal Reserve interest-rate increase next month is as certain as death and taxes for bond traders, as speculation mounts that Donald Trump’s reflationary policies will mean a quicker pace of monetary tightening.

The market-implied odds of action at the central bank’s December 13-14 meeting have reached 100 per cent, according to Bloomberg calculations based on futures. An auction of two-year Treasuries Monday drew the highest yield since 2009 before a sale of five-year debt Tuesday. A bond market gauge of inflation expectations is close to its highest level since 2015.

President-elect Trump campaigned on promises of “massive” tax cuts and spending of as much as $1 trillion over a decade to rebuild the nation’s infrastructure. His unexpected victory in the November 8 election spurred a rout in bonds, a surge in the dollar and gains in stocks. A rate hike “could well become appropriate relatively soon,” Fed Chair Janet Yellen said last week.

“After the Trump Shock, it’s easy for the Fed to hike, because inflation expectations have gone up,” as have stocks, said Hideaki Kuriki, a debt investor in Tokyo at Sumitomo Mitsui Trust Asset Management. He said he’s “100 per cent” certain of tightening next month.

The benchmark 10-year note yielded 2.32 per cent, after reaching 2.36 per cent Friday, the highest since November 2015.

The difference between yields on 10-year notes and similar-maturity Treasury Inflation Protected Securities, a gauge of expectations for consumer prices over the life of the debt, has climbed to 1.95 per cent from as low as 1.12 per cent in February.

Treasury 10-year yields of around 2.3 per cent are attracting Japanese and European investors, though US funds are expecting them to rise further, Sumitomo Mitsui’s Kuriki said. They will climb to around 2.5 per cent once investors become more concerned about the fiscal deficit under a Trump administration, and the break-even rate may reach 3 per cent, he said.

The yield will rise to 2.5 per cent at the end of 2017, according to a Bloomberg survey of analysts with the most recent forecasts given the heaviest weighting.

Wall Street dealers bought more than half of Monday’s US$26 billion two-year auction, as investor demand waned before next month’s Fed meeting. The Treasury is scheduled to sell $28 billion of five-year notes Tuesday.