U.S. Treasury holders price in end of low-rate era
Reuters, 01.30.04, 2:34 PM ET
By Amanda Cooper
NEW YORK, Jan 30 (Reuters) - All bets on a long period of low U.S. interest rates seem to have been called off in the Treasury market after the Federal Reserve seemingly dropped its vow to keep monetary policy loose for a long time to come.
The Fed this week swapped its commitment to keep rates low for a "considerable period" for being "patient" with tightening the reins on policy, which many took as a sign that the bank would raise rates at will.
Investors are putting their money where their mouths are and the fixed income market has sharply reversed its expectations for monetary policy.
"Personally I think they (Fed) are being a little bit too cute in the way they're conducting policy and I think they need to act sooner rather than later," said Michael Kastner head of taxable fixed income at Deutsche Bank Private Banking, which has $10 billion in assets under management.
The Fed's "considerable period" pledge lulled many bondholders into a false sense of security that the labor market would dictate the pace of rate rises and that the bank would not budge until it saw sustained job creation.
The difference between the yields on two-year Treasury notes and the prevailing Fed funds rate, currently at 1.00 percent, offers one of the best indications of what the market thinks will happen with interest rates.
When the Fed dropped its bombshell on Wednesday, yields on two-year Treasuries, the most sensitive to monetary policy shifts, staged their largest one-day rise in a year, and are now at a near-one month high close to 2.00 percent.
"Before we get our first Fed rate hike we will probably see the overnight-rate (over) two-year (yields) at 150 basis points, so I think we'll have the two-year note up to about 2.50 percent before we get that first hike," he said.
The two-year note <US2YT=RR> is currently trading at a premium of 86 basis points above the Fed funds rate.
PLENTY MORE TO GO
This would imply the bond market has a way to go before it fully reflects the shift in expectations.
The yield curve, a graph depicting the yields of different-dated Treasuries, is close to its flattest since early December.
Analysts said however that the curve has been very much distorted by Asian central banks buying vast amounts of Treasuries over the last year.
Japanese Finance Ministry data showed on Friday the Bank of Japan spent a record $68 billion in January alone to keep the yen from rising, and much of this cash is thought to be going into short-dated U.S. debt.
The yield curve tells investors where to get the most bang for their buck and the fall in short-term yields has outstripped that of longer yields would suggest a reflection of the view that rate rises will come sooner rather than later.
"We think rates are going to go up, we think the Fed probably won't until the second half (of the year) but the thing is, the market will move ahead of the Fed," said Mark Kiesel, executive vice president and senior member of the investment strategy and portfolio management group of PIMCO, the world's largest bond fund manager.
California-based PIMCO manages over $350 billion in assets and specializes in fixed-income securities.
But analysts said the market maybe reflecting excess pessimism as there is no real evidence yet of inflation, which would be the clincher for a rate hike.
"People have have been waiting for (Treasury) yields to rise explosively for some time and I do think that kind of build-up and anticipation somehow seeps its way into investment strategy and emotions get the better of you," said Ralph Axel, fixed-income strategist at HSBC Securities USA.
"It's the data which is going to have the ultimate say in the situation and there's nothing in the inflation data that would warrant a move and nothing I can see in FOMC's statement that would warrant one either," he said.
Copyright 2004, Reuters News Service
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