U.S. Government Bonds Slide on FED Rate Hike Expectations

U.S. Government Bonds Slide on FED Rate Hike Expectations

18 May 2016, 15:29
Roberto Jacobs
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U.S. Government Bonds Slide on FED Rate Hike Expectations

The U.S. government bonds continue to trade lower on Wednesday after reading strong April consumer price index and hawkish comments from Federal Reserve officials. The yield on the benchmark 10-year Treasury note which moves inversely to its price rose 3bps to 1.786 pct and the yield on the short-term 2-year Treasury bond also jumped 2bps to 0.847 pct by 1220 GMT.

Yesterday, the U.S consumer price index (CPI) increased 0.4 pct m/m, above expectations for a 0.3 pct m/m, from the unrevised 0.1 pct m/m result that occurred in March. Meanwhile, core CPI came in +0.2% m/m in April, in the line with expectations for a 0.2 pct m/m increase as compared to unrevised 0.1 pct m/m reading seen in March. Despite the overall dampness seen in recent months, we expect a gradual pick-up in inflation readings will be seen in the months ahead. However, we are unlikely to see a substantial move towards the Fed's 2 pct objective until we see greater traction from wage pressures. Moreover, the April Commerce Department housing starts and building permits report registered an increase in housing starts to 1172k, which rose 6.6 pct m/m, well above market expectations for a 1135k, from the revised 1099k reading seen in March (previous 1089k). Meanwhile, building permits rose 3.6 pct m/m to 1116k in April, below market expectations for a 1130k result, as compared to the revised 1077k reading that occurred in March (previous was 1086k). Alongside the increase seen in starts, we expect broader improvement is likely to be seen in the months ahead as production gradually improves, despite any lingering headwinds.

In addition, the Dallas Fed President Kaplan said that he sees the US economy strong enough to justify a rate hike in the not too distant future. Kaplan noted that the Fed wants to normalize rates but due to global headwinds there is limit to how fast they can go. It is relatively hawkish commentary from the non-voter. Although we see rates moving higher in the second half of 2016 we are reluctant to buy into the notion that the FOMC as a whole is pushing to raise rates, particularly given the dovish tone set by the April statement. Similarly, San Francisco Fed President Williams said that the data to his mind are lining up to make a good case for rate increases in the next few meetings, not just June, which means it’s very live in terms of that, adding that if we stay on the good path which we’re on, then if we were to raise two or three times this year it wouldn’t be that much of a surprise.

However, markets now await minutes from the April FOMC meeting on Wednesday (1800 GMT), which could provide some details of growing dissent with the current extended pause, adding some support to more hawkish sentiment seen recently. Meanwhile, S&P 500 Futures fell 0.17 pts to 2,040 by 1220 GMT.

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