Bond traders say don't count out June hike after Yellen remarks

Treasuries traders who delayed holiday getaway plans on Friday took away a clear message from Federal Reserve Chair Janet Yellen - a mid-year interest-rate hike may be on the way.

Yellen's remark that the Fed will raise rates "probably in the coming months" drove benchmark two-year note yields higher for a third consecutive week. The comments at an afternoon appearance at Harvard University followed those from other Fed officials who signalled that the Federal Open Market Committee's 14-15 June meeting is "live."

The market-implied probability of a rate increase next month has risen to 30 per cent, from 12 per cent at the end of April. For the following meeting, in July, the chances exceed 50 per cent. The shift in sentiment shows traders may be giving more credence to the Fed's projection of two more rate boosts this year, after policy makers lifted their overnight benchmark from near zero in December.
 

"June is certainly still live," said Aaron Kohli, a fixed-income strategist in New York at BMO Capital Markets, one of 23 primary dealers that trade with the Fed. "She's joining the rest of the FOMC - ready to go in the coming months. Yields really do need to reprice higher materially."

Yields on two-year notes, the coupon securities most sensitive to Fed expectations, rose four basis points, or 0.04 percentage point, to 0.91 per cent as of 2 pm New York time, according to Bloomberg Bond Trader data. Yields hadn't risen for three straight weeks since March. The price of the 0.875 per cent security due in May 2018 was 99 30/32.

"It's appropriate - and I've said this in the past - for the Fed to gradually and cautiously increase our overnight interest rate over time," Yellen said. "Probably in the coming months such a move would be appropriate."

The Harvard event's Friday afternoon start time, heading into a three-day weekend, had some traders delaying holiday getaways. The bond market closed early Friday, minutes after Yellen wrapped up her appearance, and will remain shut on 30 May in observance of the US Memorial Day holiday.

Several regional Fed presidents have signalled in recent weeks higher rates are ahead. San Francisco Fed President John Williams and Atlanta Fed President Dennis Lockhart said two or three increases are possible in 2016, while Boston Fed President Eric Rosengren said the likelihood is higher than the market was pricing in.

Hedge-fund managers and other large speculators in the futures market have already ramped up bets on losses in two-year notes, holding the biggest short position in the maturity since 2014, according to data as of 24 May from the Commodity Futures Trading Commission.

The snapshot provided by those figures followed the 18 May release of minutes from the Fed's April meeting, when officials signalled a move in June would be warranted if economic data indicate stronger growth and inflation.

Reports next week are forecast to show manufacturing expanding and growth in employment. The economy grew at a slightly faster pace in the first quarter than initially estimated, Commerce Department data showed Friday.