Treasury Market Braces for Higher Interest Rates
By CYNTHIA LIN
NEW YORK—While Federal Reserve officials openly feud over the right time to begin tightening monetary policy, Treasury investors are starting to lean with the hawks.
U.S. Treasurys last week endured their longest losing streak in more than two decades—nine consecutive days—and ended the worst quarter since late 2009 as U.S. government bondholders brace for the end of "quantitative easing" and a sooner-than-expected interest-rate increase.
The yield on the two-year note, which is traditionally the most sensitive to shifting monetary-policy outlooks, touched 0.901% on Friday, the highest level since May 10, before trading at 0.805% late in the day. Although Fed Chairman Ben Bernanke could pour some cold water on that speculation when he speaks later Monday, there is a sense that the train toward tighter monetary policy is now in motion.
"There have been very divergent views from the FOMC ... but people need to take on board this gradual shift toward a less-accommodative stance," said Marc Ostwald, a strategist at Monument Securities. "And the more of that there is, the more upward pressure we're going to see on yields."
Mr. Bernanke's much-awaited speech in Stone Mountain, Ga., will add to a cacophony of speakers from the Fed, including some who offered especially hawkish appraisals of the inflation outlook.
While most believe Mr. Bernanke will echo New York Fed President William Dudley's defense of accommodative rates and of seeing the $600 billion bond-buying program to the end, analysts say a hint of bias toward tighter monetary policy could signal a key turning point for financial markets.
Reputed Fed hawks have dominated the spotlight in recent days, including Philadelphia Fed President Charles Plosser and Richmond Fed President Jeffrey Lacker, who both warned on Friday that rates may need to increase before year-end. Friday's monthly jobs report was a further drag on Treasurys, as signs of a strengthening U.S. labor force provided more ammunition for those eager to shift to a tighter policy.
But dovish counterpoints by Mr. Dudley managed to pull Treasurys back into positive territory by late Friday. He argued that unemployment was still "much too high" and he saw "no reason to back away from QE2," as the current round of quantitative easing has been dubbed.
"Debates emerging from the past week show that there are major differences in policy prescriptions among FOMC [Federal Open Market Committee] members," said Ward McCarthy, chief financial economist at primary dealer Jefferies & Co. "This is the beginning of a long debate, and it's probably only going to get more heated."
Amid the Fed chatter, Treasurys investors are hoping for more relief from more dovish Fed speakers. Beneath the rosy jobs report, analysts say flat wages ease inflation pressures and suggest tighter consumer spending down the line.
"Now that the hawks have spoken, we're probably ready to move into a more aggressive stance, [though] we do think the doves should come back," said Rohit Garg, U.S. interest rate strategist at BNP Paribas in New York. Mr. Garg added that two-year notes will likely bear the brunt of the Fed's tug of war.
Following Mr. Bernanke, Fed officials scheduled to speak include Mr. Lacker, Atlanta Fed President Dennis P. Lockhart, Fed Vice Chairman Janet Yellen and Minneapolis Fed President Narayana Kocherlakota.
Elsewhere, European Central Bank members meet on Thursday and a rate increase is widely expected despite ongoing credit woes in the euro-zone periphery.
Ongoing conflict in the Middle East and North Africa and the aftermath of Japan's earthquake and tsunami also continue to serve as sources of uncertainty for global financial markets, intermittently prompting safe-haven bids into U.S. Treasurys.