Why JPMorgan sees September liftoff but cuts bond yield forecasts

Treasuries rose Tuesday, with 10-year-note yields dropping to the lowest in more than two months, after China’s devaluation of the yuan sparked a plunge in global stocks and commodities, fueling speculation the Federal Reserve may delay an increase in interest rates. “If the Fed starts to hike rates in September, it will bring stress to the markets”. The new bonds were sold at the lowest yield since April. The 10-year note fell 18/32 to yield 2.2395 percent, while the 3-year was off 1/32 in price and yielding 1.0707 percent. That’s not the doomsday scenario portrayed by those who said the size of the holdings – which peaked at $US1.65 trillion in 2014 – would leave the US vulnerable to China’s whims.

The yield recently bounced back to 2.118%, compared with 2.139% Tuesday.

“China may be stepping away, but there is such a deep and broad buyer base for Treasurys, particularly when you have times of uncertainty”, Brandon Swensen, the co-head of U.S. fixed-income at RBC Global Asset Management, told Bloomberg.

The auction results suggest that the bond market’s recent rally that sent yields to the lowest level in more than three months diluted buying interest. As inflation concerns dial back, it boosts the allure to hold long-term Treasury debt.

The 30-year Treasury was last up 20/32 and yielding 2.7767 percent, a level last seen April 29.

Prices for the 10-year note recovered some as traders readied for a $24 billion auction of the maturity later on Wednesday. The volume-weighted average of the benchmark seven-day repurchase agreement rate was up 3 basis points from Monday’s close to 2.44 per cent by late Wednesday afternoon.

“We are seeing a global risk off move, with worries around China clouding the outlook for inflation and leading to a reappraisal of whether the Fed will raise rates in September”, said Commerzbank strategist David Schnautz.

Investors expect these inflation and growth concerns to complicate plans for U.S. policymakers to raise interest rates for the first time in almost a decade.

“China is a house of cards as it slows world economy and lowers inflation”, said Thomas Roth, executive director in the U.S. government bond trading group at Mitsubishi UFJ Securities (USA) Inc.in New York. “Whether it is justified or not is another story”. Investors are concerned that equity prices, which hit record highs earlier this year, could fall due to a shift by the Fed into less-accommodative policy. “We hoped we would never see the 10-year yield drop below 2% – but at this point it looks very possible”, Madigan said.