Global Bonds Post Biggest Decline Since 2013 on Fed View

By Susanne Walker  

Global government bonds posted the biggest two-week drop in 14 months on concern the Federal Reserve will alter the language of next week’s policy statement to indicate officials are closer to lifting interest rates.
The Bloomberg Global Developed Sovereign Bond Index (BGSV) has fallen 2.2 percent since Aug. 29, the worst 10-day performance since June 2013. There’s a 61 percent chance the central bank will increase its benchmark rate by July 2015, up from 53 percent a month ago, federal fund futures showed. The rates outlook and a strengthening economy pushed the yield gap between U.S. 10-year Treasuries and Group of Seven peers to the highest in more than seven years. The Fed meets on policy Sept. 16-17.
“The market’s focus is turning to the
Fed meeting next week in anticipation of the change in language regarding the forward guidance,” said Gary Pollack, who manages $12 billion as head of fixed-income trading at Deutsche Bank AG’s Private Wealth Management unit in New York. “The economy looks a little bit better. It’s possible for yields to move higher next week.”
Yields on Treasury 10-year notes, the benchmark for corporate and lending rates worldwide, rose 15 basis points, or 0.15 percentage point, to 2.61 percent on the week in New York, the biggest gain since the five days ended Aug. 16, 2013, according to Bloomberg Bond Trader data. The yield touched 2.61 percent yesterday, the highest level since July 31. The 2.375 percent note due in August 2024 dropped 1 10/32, or $13.13 per $1,000 face amount, to 97 30/32.

Yield Curve

The difference between yields on two-year notes and 10-year debt, known as the yield curve, increased to 2.05 percentage points, the most since Aug. 1. A steepening yield curve suggests investors are demanding higher compensation against the risk of inflation as economic growth improves.
U.S. 10-year notes yielded 89 basis points more than Group of Seven counterparts, the widest since June 2007.
Bonds have dropped globally over the past two weeks, with German 10-year bund yields increasing 19 basis points to 1.08 percent, Japan’s 10-year yield adding eight basis points to 0.58 percent and the equivalent Australian (GACGB10) yield rising 32 basis points to 3.61 percent.
The yield premium offered by U.S. debt bolstered demand at Treasury auctions this week, drawing the strongest buying since February from a class of investors that includes foreign central banks.

Auction Demand

Indirect bidders purchased 42.5 percent of the $61 billion of three-, 10- and 30-year securities sold, according to Treasury Department data compiled by Bloomberg. Investors bid $2.91 for every $1 of debt offered, the most since June. The sales took place as benchmark 10-year note yielded the most versus its Group of Seven counterparts since 2007.
The U.S. is scheduled to sell $13 billion in 10-year inflation-indexed securities on Sept. 18. It sold $15 billion of the securities in July at a yield of 0.249 percent, the least since May 2013.
Hedge-fund managers and other large speculators increased futures bets on Treasury five-year notes in the week ending Sept. 9 to a 86,122 net-long position, the most since July 2013, according to U.S. Commodity Futures Trading Commission data. The figure compares with net longs, or bets prices will rise, of 85,202 contracts a week earlier.

‘Modestly Hawkish’

Expect a “modestly hawkish outcome” at the Federal Open Market Committee meeting primarily on expectation of a move higher in “dovish dots” and “subtle shifts” in the tone of a press conference, Barclays Plc strategists led by Rajiv Setia wrote in report dated Sept. 11.
The Fed is likely to retain the “considerable language period,” however if it is dropped, the “front end should get hurt,” he wrote.
The yield gap between two- and three-year securities expanded to 52 basis points yesterday, the most since April 2011. The spread has averaged 30 basis points over the past five years.
“The market is pricing in more consistent hikes, but still at very low levels, which is why three-year notes are seeing more weakness than two-year notes,” said Thomas Simons, a government-debt economist in New York at Jefferies LLC, one of 22 primary dealers that trade with the Fed. “It’s a more universal view that the Fed is getting closer to normalizing policy. And we are seeing that reflected in the front end.”

‘Accommodative Policy’

The U.S. economy is forecast to have grown 4.6 percent in the second quarter, according to a Bloomberg survey before the reading is released Sept. 26, up from a 4.2 percent estimate in August. The economy contracted 2.1 percent in the first three months of the year.
Researchers at the Fed Bank of San Francisco warned in a report this week that investors may be underestimating how quickly the Fed will raise interest rates,
“The public seems to expect a more accommodative policy than Federal Open Market Committee participants,” they wrote.
The Fed is reducing the monthly bond purchases it has used to support the economy, cutting the amount at its previous meeting in July by $10 billion to $25 billion. Policy makers are on track to end the program this year.
The central bank reiterated it will probably keep the target for its benchmark interest rate in a range of zero to 0.25 percent for a “considerable time” after the asset purchases end.