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Treasuries traders bet Fed minutes will keep the rate door open

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(Bloomberg) — Treasuries fell for a third day, pushing two-year yields to the highest since April, amid speculation that minutes of the Federal Reserve’s last meeting will signal policy makers intend to stick to their plan to raise interest rates twice this year.

The extra yield that 10-year notes offer over two-year securities reached the lowest since 2007 on Wednesday, before the 2 p.m. New York time release of the Federal Open Market Committee’s April meeting minutes. Neuberger Berman LLC anticipates rate boosts in September and at year-end, while Morgan Stanley expects the Fed will lift rates in December. San Francisco Fed President John Williams and Atlanta Fed President Dennis Lockhart, both non-voters this year, said on Tuesday that two or three rate increases are possible in 2016.

Improving economic data, led by a stronger-than-forecast inflation report Tuesday, have buoyed expectations the FOMC will raise rates this year. The market-implied probability of a rate increase by July is about 35 percent, double what it was at the end of last week.

“We see this continued nervousness that the Fed is about to embark upon a hawkish-sounding mission, starting with today’s FOMC minutes,” said Anthony Cronin, a trader in New York at Societe Generale SA, one of the 23 primary dealers that trade with the Fed. “The front end of the curve has been complacent about the Fed not tightening this year, and now that thought process is starting to crack.”

Sensitive Coupon

The yield on the two-year note, the coupon security most sensitive to expectations for Fed policy, rose two basis points, or 0.02 percentage point, to 0.85 percent as of about 10 a.m. in New York, according to Bloomberg Bond Trader data. The price of the 0.75 percent security due in April 2018 was 99 26/32. Yields on the benchmark 10-year note climbed 5 basis points to 1.82 percent.

The Fed has to get off a “very low interest rate policy and return to rate normalization,” said Joseph Amato, chief investment officer at Neuberger Berman in New York, in an interview with Bloomberg TV. “That process is going to be slow and grinding, but it’s important for the Fed to do that.”

The market-implied probability of a rate increase rises to about 65 percent for a move by year-end, up from 53 percent at the end of last week. The calculation assumes the effective fed funds rate will average 0.625 percent after the central bank’s next increase.

“Most people on the Fed would like to keep their options open for the June meeting, so I would expect to see language in the minutes that ultimately did not end up closing the door on June,” said Matthew Hornbach, the New York-based head of global interest-rate strategy at Morgan Stanley, in an interview Tuesday. The firm has kept its call since at least March for one rate increase this year.

See also:

Federal Reserve leaves door open for June rate increase

Yellen’s scope for summer rate hike widens as ECB signals hold

Yield grab pushes U.S. Treasuries curve to flattest since 2007

Slow bleed from low bond yields drains insurers’ returns


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