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Yellen’s gradual rates path backed by bond-market inflation view

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(Bloomberg) — Janet Yellen’s emphasis on a gradual path to higher U.S. interest rates is being vindicated by a decline in the inflation outlook among traders.

The 10-year break-even rate, derived from the difference between nominal and index-linked bonds, fell to 1.83 percentage points Tuesday, the lowest close since June 1, as oil prices declined. The spread between two- and 30-year yields, which is also influenced by the inflation outlook, was at the narrowest in more than a month. Federal Reserve Chair Yellen told the Senate Banking Committee last week she prefers to “tighten in a prudent and gradual manner.” Subdued consumer-price gains lessen pressure to lift borrowing costs.

“Interest rates are likely to go up this year as signaled by the Fed, but low inflation means the pace would be gradual,” said John Stopford, London-based head of fixed income at Investec Asset Management Ltd., which oversees $120 billion. “We don’t expect yields to rise to levels seen in the previous cycle.”

The benchmark U.S. 10-year note yield fell one basis point, or 0.01 percentage point, to 2.31 percent as of 9:16 a.m. in New York, according to Bloomberg Bond Trader data. The price of the 2.125 percent security due in May 2025 was 98 11/32.

Ten-year Treasury Inflation Protected Securities yielded 0.48 percent. The U.S. plans to auction $15 billion of the bonds on Thursday.

Fed outlook

TIPS lost 0.3 percent this month, on track to underperform conventional debt for a third straight month, as a rebound in oil petered out.

Brent crude futures dropped, approaching the lowest level since April, amid signs a global supply surplus will be prolonged as Iran bids to restore output after its nuclear accord. Annual U.S. consumer-price inflation has been at 0.1 percent or lower every month this year.

Futures show a 39 percent chance the Federal Open Market Committee will raise borrowing costs in September, and 71 percent odds by year-end, according to data compiled by Bloomberg.

The yield on two-year notes — which are more sensitive to monetary-policy expectations — rose one basis point to 0.69 percent, compared with 3.06 percent for 30-year bonds. The spread narrowed to 236 basis points, the least since June 17.

“The Fed probably doesn’t want to wait until we hit exactly their targets; they need to act before, as long as they have enough confidence that we will eventually reach those targets,” Hartmut Issel, Singapore-based chief investment officer for UBS AG Wealth Management, said in an interview, adding that he’s “very overweight” U.S. high-yield bonds. “You don’t want to be behind the curve.”

–With assistance from Angie Lau in Hong Kong.


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