(Bloomberg) — US Treasuries rose as the US paused strikes on Iran and oil prices fell, with an auction of the shortest-dated notes attracting buyers ahead of this week’s Federal Reserve meeting.
The advance in US government debt on Monday sent yields lower by around one to four basis points, with those on the 10-year note down to 4.64% — off the year-to-date peak it hit last week. While traders continued to see a roughly one-in-three chance of a Fed hike this week, the recent surge in yields helped support appetite at a $69 billion auction of two-year Treasuries. A sale of five-year notes drew less demand.
“We find a lot of value in fixed income today,” said Nicolo Bocchin, global co-head of fixed income at Azimut Group, who likes shorter and mid-dated Treasuries. “I see more risk on the growth side rather than on inflationary side.”
This week’s early advance in the US bond market sets up Kevin Warsh’s second meeting at the helm of the Fed. After last week’s selloff in global bonds — which sent some yields to the highest in years — traders are still pricing in an unusually high amount of uncertainty about a potential hike in July.
Much of that has to do with Warsh’s explicit goal of avoiding commentary that would illuminate the central bank’s policy plans. While US inflation data for June showed signs of easing price pressures, a surge in oil prices last week reignited concern in the market.
The geopolitical backdrop in the Middle East remains volatile, even after US President Donald Trump said he decided to pause strikes on Iran to give negotiations another chance. Brent crude fell below $90 a barrel.
Overnight-indexed swaps still implied an almost 40% chance of a quarter-percentage-point rate increase this week. By contrast, almost all economists surveyed by Bloomberg see the Fed keeping rates unchanged. Traders are fully pricing in a hike by September.
“There should be a good ‘family fight’ on the inflation outlook and forward policy-settings,” said John Brady, managing director at RJ O’Brien. “Our sense this morning is that this Warsh Fed will use this meeting to prepare the markets for a September rate hike.”
Interest-rate strategists at Bank of America Corp. and JPMorgan Chase & Co. also expect the hawkishness from Fed officials will add upward pressure to yields. Bank of America recommends investors stay short two-year Treasuries, which are most sensitive to changes in the Fed’s policy.
At Standard Chartered, US rates strategist John Davies warned that a return of the 10-year yield to around 5% couldn’t be ruled out.
Over the past month, the bulk of US bond losses has been powered by rising real yields, which are adjusted for inflation and serve as a proxy for the bond market’s expectations for the Fed’s so-called neutral rate — a policy setting that neither slows nor boosts the economy.
A broad US Treasury index is down roughly 1% so far this month, as of Friday, while a long-dated index of debt due in 20 years or more has slid 3.3%, on course for its weakest month since March.
On Monday, results from the Treasury auctions offered mixed results. The two-year sale attracted solid demand, while the five-year notes were sold at yields higher than expected. That suggests that demand was stronger in the shorter-dated notes than for the longer maturity.
A sale of $44 billion seven-year notes on Tuesday will complete the Treasury coupon auction schedule for July.
What Bloomberg Strategists say…
“While the reception for 2s signaled no broad shortage of Treasury demand in policy-sensitive paper, where duration risk is limited, the weak auction metrics for 5s are more relevant for Tuesday’s sale of seven-year paper. It suggests interest evaporated in the belly, the sector that sits at the intersection of Federal Reserve policy and inflation expectations. That leaves the seven-year sale needing a meaningful concession.”
—Alyce Andres, Macro Strategist, Markets Live
For the full analysis, click here.
–With assistance from Cameron Fozi.
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