US Treasuries price in more than one Fed rate hike
By Steven Scheer
NEW YORK, May 28 (Reuters) - The question facing the U.S. Treasuries market these days is not whether or when the Federal Reserve will raise interest rates but by how much.
''We're pricing in more than one tightening when we haven't even gotten one,'' said Ray Remy, head trader at HSBC Securities Inc.
Fed policy makers on the Federal Open Market Committee (FOMC) next meet on June 29-30. Odds have risen to about 75 percent that the Fed raises rates then, market players said.
As a result, prices on short-dated U.S. Treasuries -- the most sensitive to Fed policies -- have gone into freefall, pushing two-year note yields to 10-month highs at nearly 5.5 percent from 5.12 percent two weeks ago. In the past three sessions, the two-year yield has jumped almost a 1/4-point.
In the past day or two, the market has resigned itself to a probable Fed rate hike on June 30 and perhaps another one at the next meeting in August.
''The market fears that if the Fed starts to go, it will take back more than one of last year's (three) rate cuts,'' said Patrick Dimick, senior market economist at Warburg Dillon Read LLC. ''No one thinks if they go once that will be it.''
Banking system liquidity concerns as the Year 2000 approaches bolsters the argument for the Fed to hike rates sooner than later, analysts said.
Still, some Fed watchers said a rate hike is not a foregone conclusion even though the Fed shifted to a tightening bias from a neutral stance at last week's policy meeting.
The Fed's decision likely hinges on two variables over the next month: the economic data and risk-markets performance.
The Fed would not raise rates if economic figures start revealing a slowdown, analysts said. Also, a repeat of last fall's scenario when Treasuries dramatically outperformed riskier markets like emerging, corporate and mortgage-backed debt, could keep the Fed on hold.
''The market is reaching conclusions as to what the next four weeks of data will hold and what four weeks of credit market credit spreads will bring,'' Dimick said.
Long-term Treasuries have rallied on expectations the Fed will soon raise rates. Higher rates would signal the Fed is serious about its commitment to keep inflation tame.
The Treasury market wavered for weeks about whether the Fed would raise rates. Far more people jumped on the Fed tightening bandwagon after April's Consumer Price Index jumped 0.7 percent, the largest monthly increase since October 1990.
The market's conviction that a rate hike is near became evident this week when the Treasury held a two-year note auction and no one showed up, leaving dealers with a huge pile of supply to try and dump.
''It woke the dealer community up to the fact there are no true investors out there until they get greater assurances the Fed will stay on hold,'' said Elliott Platt, director of economic research at Donaldson Lufkin & Jenrette Securities Corp. ''Retail investors are not there.''
Platt, though, believes there is only one rate hike priced in right now.
''If we get a tightening ... I suspect the two-year (yield) will move into a 5.5 to 5.75 percent zone,'' he said. ''The market will not be happy with two-year yields 50 basis points over fed funds.''
The federal funds rate, the rate banks charge other banks for overnight loans, is currently 4.75 percent. |
