Flattest yields since 2007 misprice Fed, says Goldman Sach’s Hatzius

Bloomberg

Jan Hatzius, the chief economist at Goldman Sachs Group Inc., warned bond investors aren’t prepared for the Federal Reserve to raise interest rates.
Fed Bank of Atlanta President Dennis Lockhart and his San Francisco counterpart John Williams both said that at least two rate increases may be warranted this year as the economy picks up.
Their comments echo those of Bill Gross, the former manager of the world’s biggest bond fund, who said this month not to count the Fed out after a weaker-than-expected jobs report.
The views contrast with the Treasury market, where the range of maturities comprising the yield curve suggest investors are preparing for slowing inflation as much as higher borrowing costs.
Demand for long-term debt has narrowed the yield premium on 10-year notes over two-year securities to as little as 92 basis points, the least since 2007.
“The market’s underestimating their willingness to follow through on what they say,” Hatzius said in an interview on Bloomberg Television.
“If you look at where the yield curve is priced — how little
normalization of monetary policy is discounted — that’s very
striking.”
Benchmark Treasuries put a good show forward and they were little changed on Wednesday, with the 10-year note yield at 1.77 percent in London.
Hatzius also said in February the bond market was underestimating the Fed, and he predicted 10-year yields would rise to about 3 percent by year-end.
They’ve fallen about seven basis points from the closing level on February 4 when he made the comments. Goldman Sachs is one of the 23 primary dealers that trade directly with the US central bank.
Futures contracts show a 12 percent probability policy makers will raise rates at their next meeting on June 14-15. However, the odds of a shift by year-end are nearly 65 percent, according to the data based on fed fund
futures.
Interestingly, the market is signalling a severe risk of a contraction, said Steve Major, the head of the fixed-income research at HSBC Holdings Plc in London. The long-term yields are declining around the world as central banks, including the Fed, struggle to spur inflation, he pointed out.