Investors see higher yields as U.S. jobs data resets Fed calculus
By Richard Leong
NEW YORK (Reuters) - Before last Friday, many investors opined that the U.S. Federal Reserve would probably raise interest rates only once this year. Making the first hike in about nine years would be almost symbolic, as if the central bank was showing it still knew how.
Fewer investors are talking symbolism now after an unexpectedly strong February jobs report indicated the economy may be picking up steam. Dramatic moves in the bond market, along with gains in the U.S. dollar, show that more investors are positioning for a series of rate increases in 2015, rather than a token move.
Friday saw short-dated bond yields see their biggest gains in a month as more buysiders started to come in line with the thinking of big brokerages who see the Fed raising rates multiple times in the second half of 2015. And long-term rates rose even further, with the 10-year yield posting its biggest move in more than a year.
Prior to the jobs data, many investors had priced in the timing of the first rate increase for late this year, with some still thinking a move might not happen at all in 2015.
"It really drives home how much of a recovery we've seen," said Kristina Hooper, head of portfolio strategies at Allianz Global Investors in New York, which manages $499 billion. "It has changed market sentiment."
The spike in yields has led some investors to become reticent to own too many Treasuries and to consider holding riskier and higher-yielding bonds.
Speculators taking short positions against the benchmark 10-year TYv1 in the futures markets are likely to boost those bets, which were at a seven-week high prior to the jobs report. Bank of America Merrill Lynch analysts said on Monday it might be the most profitable time ever to bet on short-dated U.S. rates to spike higher.
To be sure, evidence of weakening U.S. growth or another flare-up between Greece and its European creditors could cause investors to rethink whether Fed chair Janet Yellen and other top Fed policy-makers will soon hike rates. Some economists including Lawrence Summers point to scant evidence of inflation, particularly in wages, and have urged the Fed to not raise rates "until it sees the whites of inflation's eyes."
Prospects that the Fed might tighten this summer is driving more money out of funds focused on long-dated Treasuries. For example, BlackRock's iBoxx investment-grade corporate bond ETF LQD.P, which buys securities with higher yields than government debt, saw $1.4 billion in inflows in February, compared with $90 million outflows from its iShares 20+ year Treasury bond ETF TLT.P.
"The Treasuries market is still quite expensive with yields quite low. We think there is better opportunity to rotate into corporate and emerging market bonds," said John Bellows, portfolio manager at Western Asset Management Co in Pasadena, California, with $466 billion in assets.
The equity market hasn't been immune, either, with the Standard & Poor's 500 Index down 2.2 percent since Thursday's close.
Futures markets suggest a U.S. rate increase in June is back in play. The altered outlook on the timing and pace of a Fed "lift-off" brings them closer to the consensus long-held among some longer-term investors and Wall Street economists. A Reuters poll conducted Friday after the jobs report shows many Wall Street firms see the first hike coming in June.
On Friday, the two-year Treasuries yield US2YT=RR rose to almost 0.75 percent, highest since late December. Its yield against long-dated yields grew to its widest in more than two months, suggesting traders see the pace of rate increases to be faster than they had thought.
The dollar index, meanwhile, has risen 9.1 percent against a basket of major currencies in 2015, following a 12.8 percent gain in 2014, the biggest gains since 1997.
The bond market has played this game in previous years, with a sharp rise in yields early in the year, only to decline in the summer as growth disappoints. If that happens again, and the Fed opts to postpone a rate hike, it might spark a rally in bonds and stocks, and cool the dollar.
Foreigners' interest in Treasuries as the European Central Bank begins a one-trillion-euro bond purchase program may help keep longer-dated yields a bit lower.
"I think long-term rates could stay low on a lot of forces, but we are in an environment where short-term rates would be moving higher as we move closer to lift-off," said Bill Irving, a Merrimack, New Hampshire, portfolio manager at Fidelity Investments that manages $870 billion in bonds.
(Reporting by Richard Leong. Editing by David Gaffen and John Pickering)
