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 A wide range of short-term interest rates, which tend to be the most
sensitive to Fed policy expectations, has been quietly grinding
higher for weeks, or in some cases much longer. Several have even
surpassed their levels of two years ago during the bond market's
"taper tantrum," when prices dropped steeply and yields shot up as
the Fed pondered whether to halt its massive asset-purchase program.
Banks, money market mutual funds and other investors do not want to
be stuck with low-yielding debt when the U.S. central bank finally
does begin raising interest rates, something it last did in June
2006. Generally positive comments about the economy by the Fed at
the conclusion of its latest policy meeting on Wednesday signaled to
many that a rate rise could come as early as September.
"The confidence is starting to rise about a rate hike," said
Gennadiy Goldberg, interest rate strategist at TD Securities in New
York. "You want to be compensated for at least one hike."
For example, overnight bank borrowing rates have been inching up for
the better part of a year and are around 36 percent more costly than
in May 2014, when they fell to a record low.
Yields on investment-grade corporate bonds are holding near recent
two-year highs, and the premium paid for holding them relative to
Treasuries is the steepest since September 2013.
And even as yields on bond market benchmarks such as the 10-year
Treasury note and 30-year T-bond have seen only intermittent upward
pressure, those on shorter-dated Treasuries are decidedly higher.
The yield on two-year Treasury notes, at 0.73 percent on Thursday,
was just a tick from a four-year high and more than three times that
of May 2013. Rates on T-bills with durations of less than a year are
at their highest so far this year.
Yields, or rates, move inversely to the price of bonds.
To be sure, yields on two-year Treasuries slid back to 0.66 percent
on Friday after a key measure of U.S. employment costs came in far
weaker than expected, suggesting the Fed may not get the wage gains
it seeks before raising rates.
The Fed could still blink in the face of such factors as Greece's
unresolved debt woes and stock market turmoil in China, the world's
second largest. And a fresh bout of weakness in oil markets could
make it difficult for inflation to move in the direction desired by
the Fed.
To that end, some measures of Fed rate expectations suggest almost
no probability the central bank will move before December. Prices of
Fed fund futures reflect a zero percent chance of a rate increase in
September, a 37 percent chance in October and a 64 percent chance in
December, according to CME Group's FedWatch.
The Fed has long emphasized that it expects to raise interest rates
only gradually, unlike in the last decade, when policymakers raised
borrowing costs slightly at every meeting.
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In recent weeks and months, policymakers have stressed that the
timing of the initial rate rise is less important than how the
economy evolves afterward. Cleveland Fed President Loretta Mester
even gave a speech this month entitled "Timing isn't Everything."
WHITES OF FED'S EYES
Overnight borrowing costs between banks are a reliable proxy that
traders expect short-term U.S. rates to head higher sooner than
later.
Since the Fed has increasingly de-emphasized the timing of a first
rate increase, and especially since Fed Chair Janet Yellen's
mid-July testimony to Congress, "the markets started to price in a
more hawkish Fed," said Com Crocker, managing director of global
inflation markets at Mesirow Financial in New York.
"You saw it in rates, you saw it in the curve, you saw it in the
dollar, in commodities, in stocks and in everything," he said.
The federal funds effective rate, which the Fed seeks to control,
has averaged 0.14 percent for four days in a row, matching its
highest since May 2013. That is 1.5 basis points above the midpoint
of the zero-to-25-basis-point target range the Fed adopted in
December 2008.
The bottom range of fed funds trading climbed to 0.10 percent on
Thursday, a level last seen in 2011.
Another key rate, the three-month London interbank offered rate, or
Libor, a benchmark for $350 trillion worth of financial products
worldwide, topped 30 basis points on Wednesday for the first time
since January 2013. On Friday, Libor rose the most since 2011.
And a type of interest rate swap designed to anticipate the Fed
policy rate around the time of its next meeting in September now
reflects a rate around 2 basis points above the top of the Fed's
current target range.
For some, though, the most telling signal in recent days is the rise
of yields on Treasury bills.
The interest rate on three-month T-bills that mature on Sept. 17,
when the Fed releases its next policy meeting statement, rose to
almost 7 basis points on Thursday, the most in nearly 14 months.
"T-bill rates are usually the last to move. They only move when they
see the whites of the Fed's eyes," TD's Goldberg said.
(Editing by Dan Burns, Leslie Adler and Steve Orlofsky)
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