USA 2-Year Treasury Yield Rises as Markets Place Fed Rate Hike Bets

“We believe at some point in the near future the rate hike cycle needs to begin in order for the Fed to retain its credibility with the markets and to remind investors that rates can not stay at zero forever”.

“[Thursday’s] decision further extends the uncertainty that investors have been dealing with for several months“, Spika said.

Bond markets, perhaps the asset classes most affected by interest rates changes, benefited from the decision to keep rate close to zero, with yields of European Sovereign Bonds declining across the board, and US Treasuries poised to post sizable gains.

Bond yields also fell in Japan, Singapore, Korea and New Zealand on the Fed’s decision and commentary. But Vanguard fixed-income guru Ken Volpert shared a refinement to that rule of thumb: To estimate how much an investor could lose during a 12-month period if Treasury yields increased by 1 percentage point during that same 12 months, subtract a fund’s SEC yield from its current duration. The 10-year Treasury yield is 2.15 percent today, down from 4 percent at the start of 2008, which means bond funds will likely provide less protection in the next steep decline for stocks.

Illustrating that policy divergence, the gap between short-dated US and European yields is at its widest in over eight years.

Two-year notes were last up 1/32 in price to yield 0.68 percent, from a yield of 0.70 percent late Thursday. Investors have been fretting for years that interest rates are set to rise, something that would knock down bond prices.

Even as analysts parse every word in the Federal Reserve’s statements and from Fed Chair Janet Yellen’s press conference on Thursday, long-term investors should not focus on headlines that may cause short-term market fluctuations. The odds of a rate increase at the December meeting were 41%.

These bets panned out earlier this year as the 10-year yield reached 2.5% in June, the highest intraday level since September 2014.

Bond funds have historically helped give a sense of security when the stock market plummets.

“Things were quiet and then suddenly they were springing to life”, said Tom di Galoma, head of rates and credit trading in New York at ED&F Man Capital Markets. That means the rout in global bonds is far from over, so even though their yields are now even higher, they’re likely in for more turbulence.

Another appeal to buy long-term bonds: tame inflation. Investors interpreted the move as a signal that the global economy is weak. Inflation is the main threat because it chips away bonds’ fixed return over time.

While he was not surprised by the Fed announcement, Rieder said he was surprised that the Fed did not leave more room for rate increase in October.

While the US job market since 2013 has created jobs at the fastest pace since the late 1990s, tepid wage growth and plunging commodity prices have kept inflation rates below the Fed’s 2% target.

“Their interest rate projections show that 13 of 17 policy makers see higher rates by the end of 2015”.

“The Fed statement today can best be characterised as a very dovish punt”, Richard Clarida, global strategic adviser at Pimco, told Bloomberg.

“This is a short-term concern but there are other factors that would provide support for long-term bonds”, said Patrick Maldari, money manager at Aberdeen Asset Management, which has $483.3 billion in global assets under management.