Justin Lederer Comments: Two-Year U.S. Bond Yield Rises Above 1%

 December 25, 2015, NASDAQ

The yield on two-year U.S. government debt rose above 1% and approached a five-year high Thursday, as investors shed holdings ahead of fresh debt supply in the coming week. 

Trading continued to be thinner than usual with many investors out for the holidays, which may exaggerate price swings in financial markets. 

"The path of least resistance is probably higher in yield, though it may end up being more of a drift," said John Briggs, head of strategy for Americas at RBS Securities. 

The yield on the two-year note settled at 1.002% in a shortened trading session, up from 0.985% Wednesday. Bond yields rise as their prices fall. 

The yield closed at 1.008% on Dec. 16-the highest closing level since April 2010-after the Federal Reserve decided to raise its benchmark short-term interest rates for the first time since 2006. Short-term yields are highly sensitive to expected changes in the Fed’s rate policy. 

Long-term bonds, which won’t face fresh supply pressure soon, fared better as buyers stepped in after a two-day price decline. 

The yield on the benchmark 10-year Treasury note fell to 2.241% from 2.262% Wednesday. The 30-year bond’s yield declined to 2.962% from 2.998%. 

The Treasury announced Thursday that it will sell $26 billion of two-year notes next Monday, followed by $35 billion of five-year notes and $29 billion of seven-year notes in the following two sessions. The $90 billion package is unchanged from a month ago and matched bond dealers’ expectations. 

It will be the last round of Treasury debt offerings in 2015, but the sales come after the Fed’s rate increase. Traders say next week’s auctions will be a test of demand for short-term debt following the Fed’s policy shift. 

Some have a cautious outlook of the sales as many investors wait for early January to make fresh investment decisions, though they don’t expect sloppy demand, especially with the rise in yields over the past two months. 

"I think [there] would be buyers at these yield levels," said Justin Lederer, senior trader of interest rates at Cantor Fitzgerald in New York. "The Fed is going to be slow in raising rates. There is still demand for safe-haven assets. Banks still need short-term liquid assets due to regulations." 

The two-year yield has risen from 0.668%, the level where it settled at the end of 2014. 

In contrast, long-term bond yields barely budged. The 10-year yield, a foundation for global finance, is near 2.173%, where it traded at the end of last year. 

The resilience of long-term government bonds has confounded many hedge funds, money managers and bank traders who had expected the yield to rise toward 3% by the end of the year. The Fed’s rate policy has a more subdued effect on long- term bond yields which are more influenced by global economics and the inflation outlook. 

A sluggish global growth outlook and contained inflation continue to draw buyers into Treasury debt, which offers one of the most attractive yields among government bond markets in the developed world. 

Investors continued to grapple with a muddy growth outlook. Concerns remain about whether oil prices may fall further from their low levels amid tepid global demand and a supply glut. Investors are keeping an eye on China’s slowing economy, as well as bonds sold by lower-rated U.S. firms, or junk bonds, which have taken a beating this month, deepening this year’s price slump. 

Some money managers say long-term bond yields could see a swifter increase in 2016 if the global economy picks up steam or inflation markers, such as U.S. wage pressure, flare up. 

COUPON ISSUE PRICE CHANGE YIELD CHANGE 

7/8% 2-year 99 24/32 dn 1/32 1.002% +2.6BP 

1 1/4% 3-year 99 25/32 flat 1.325% flat 

1 5/8% 5-year 99 18/32 up 1/32 1.718% -0.6BP 

2% 7-year 99 20/32 up 2/32 2.056% -1.1BP 

2 1/4% 10-year 100 1/32 up 5/32 2.241% -1.9BP 

3% 30-year 100 21/32 up 20/32 2.962% -3.1BP 

2-10-Yr Yield Spread: +123.9BPS +127.7BPS