Fed hike Is certainty for bond traders as market odds reach 100%

Bloomberg.- A Federal Reserve interest-rate increase next month is as certain as death and taxes for bond traders, as speculation mounts that Donald Trump’s reflationary policies will mean a quicker pace of monetary tightening.

The market-implied odds of action at the central bank’s Dec. 13-14 meeting reached 100 percent for the first time, according to Bloomberg calculations based on futures. An auction of two-year Treasuries Monday drew the highest yield since 2009 before a sale of five-year debt Tuesday. A bond market gauge of inflation expectations was headed for its highest close since October 2014.

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President-elect Trump campaigned on promises of “massive” tax cuts and spending of as much as $1 trillion over a decade to rebuild the nation’s infrastructure. His unexpected victory in the Nov. 8 election spurred a rout in bonds, a surge in the dollar, and gains in stocks. All four major U.S. equity benchmarks climbed to records on Monday. A rate hike “could well become appropriate relatively soon,” Fed Chair Janet Yellen said last week.

“After the Trump Shock, it’s easy for the Fed to hike, because inflation expectations have gone up and the New York Dow has gone up,” said Hideaki Kuriki, a debt investor in Tokyo at Sumitomo Mitsui Trust Asset Management. He said he is “100 percent” certain of tightening next month.

The two-year Treasury note yield climbed two basis points to 1.10 percent as of 6:20 a.m. in New York, according to Bloomberg Bond Trader Data. That’s the highest since 2010. The benchmark 10-year yield dropped two basis points to 2.30 percent, after reaching 2.36 percent on Friday, the highest since November 2015.

The difference between yields on 10-year notes and similar-maturity Treasury Inflation Protected Securities, a gauge of expectations for consumer prices over the life of the debt, has climbed to 1.95 percent from as low as 1.12 percent in February.

Japanese Attracted

Treasury 10-year yields of around 2.3 percent are attracting Japanese and European investors, though U.S. funds are expecting them to rise further, Sumitomo Mitsui’s Kuriki said. They will climb to around 2.5 percent once investors become more concerned about the fiscal deficit under a Trump administration, and the break-even rate may reach 3 percent, he said.

The yield will rise to 2.5 percent at the end of 2017, according to a Bloomberg survey of analysts with the most recent forecasts given the heaviest weighting.

Wall Street dealers bought more than half of Monday’s $26 billion two-year Treasury auction, as investor demand waned before next month’s Fed meeting. The Treasury is scheduled to sell $28 billion of five-year notes Tuesday.

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