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Bond market says cheaper yuan won’t stop Fed from raising rates

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(Bloomberg) — The bond market is saying China’s decision to devalue the yuan won’t stop the Federal Reserve from raising interest rates.

Futures contracts indicate traders see a 50 percent chance the U.S. central bank will increase official borrowing costs at policy makers’ Sept. 16-17 meeting, up from 40 percent odds on Aug. 11, when China unexpectedly devalued its currency. At the same time, economists at the world’s biggest bond shops are paring bets on how quickly Treasury yields will rise amid global growth concerns as a bond-market inflation gauge fell to the lowest in more than six years.

“The post-liftoff pace is increasingly moving into focus, but September still matters a lot, particularly with markets still not fully prepared for it,” said Michael Leister, a senior rates strategist at Commerzbank AG in Frankfurt. “Our economists still expect a September lift-off, with markets about 50-50, hence there is room for Treasury yields to rise and the curve to flatten.”

Treasury two-year note yields, which are closely tied to expectations regarding a Fed rate increase, rose one basis point, or 0.01 percentage point, to 0.72 percent as of 1:06 p.m. New York time, according to Bloomberg Bond Trader data. Treasury 30-year yields, which are more influenced by the longer-term outlook for growth and inflation, fell three basis points to 2.83 percent.

‘Stronger’ Data

The one-year break-even rate, a bond-market inflation gauge, fell to the lowest on a closing basis since May 2009.

Benchmark Treasury 10-year yields were little changed after a report showed factory production rose more than forecast in July as automobile assembly jumped to the highest since 1978.

“The data was stronger than expected,” said Shyam Rajan, head of U.S. rates strategy at Bank of America Corp.in New York, one of the 22 primary dealers that trade with the Fed. “On the margin, some of the nervousness about the September hike around the China devaluation seems to be declining.”

An earlier Labor Department report showed wholesale prices in the U.S. climbed at a slower pace in July, a possible sign of things to come as energy prices plunge.

That report “bolstered expectations that these price pressures have been modestly building,” said Edward Acton, a U.S. government-bond strategist at Royal Bank of Scotland Group PLC’s RBS Securities unit in Stamford, Connecticut. He expects the Fed to raise rates in September. Economists confident

Economists are even more confident than the bond market that the Fed will raise borrowing costs this year. The central bank will boost its main policy rate next month for the first time since 2006, according to 77 percent of forecasters in a Bloomberg survey taken Aug. 7-12. All respondents were given the opportunity to revise their forecasts following the yuan news.

China’s yuan tumbled 1.8 percent on Aug. 11, the biggest decline in two decades, when the nation unexpectedly began devaluing its currency.

The initial reaction in the Treasuries market was a rally, driven by demand for the safest assets, on speculation the Chinese government was acting on concern that the world’s second-largest economy was slowing. Even so, 10-year Treasuries are headed for their first weekly decline since early July.

–With assistance from Wes Goodman in Singapore.