Treasuries lose their lead over shares as Fed moves towards shift

Bloomberg

Treasuries have lost their edge over stocks as the U.S. economy expands enough to push the Federal Reserve toward raising interest rates.
U.S. government securities stagnated for a second month in May, leaving them little changed for the second quarter. The S&P 500 Index of shares has returned 2.3 percent since the end of March, based on data compiled by Bloomberg. The figures are a reversal from the first three months of the year, when Treasuries beat stocks. Treasuries fell on Tuesday after being closed the previous day.
Economic data are surpassing analysts’ forecasts by the most since January 2015, based on the Bloomberg ECO U.S. Surprise Index. Figures this week include personal income and spending, along with the Fed’s preferred inflation gauge on Tuesday. The government issues its monthly employment report June 3.
“Treasury prices aren’t going up” as the Fed prepares to raise rates, said Kazuaki Oh’E, the head of fixed income at CIBC World Markets Japan Inc. in Tokyo. “In either June or July, they’re going to do it. The economy is not in a bad condition.”
Benchmark Treasury 10-year note yields rose two basis points, or 0.02 percentage point, to 1.87 percent as of 7:10 a.m. in New York, according to Bloomberg Bond Trader data. The 1.625 percent security due in May 2026 declined 6/32, or $1.88 per $1,000 face amount, to 97 25/32.
The odds of a rate increase in June implied by federal funds futures contracts were 30 percent, climbing to 74 percent by year-end. Fed Chair Janet Yellen said May 27 improvement in the U.S. economy would warrant raising interest rates in the coming months.
To find the action in the Treasury market, look at the shrinking difference between two- and 10-year yields, said Kei Katayama, a bond manager in Tokyo at Daiwa SB Investments, which has about $50 billion in assets.
The so-called spread contracted to 92 basis points on Tuesday, the narrowest level in more than eight years. Two-year yields are climbing as traders prepare for the Fed to raise rates, Katayama said. The notes are among the securities that respond most to what the central bank does with its benchmark, the target for overnight loans between banks, because of their short
maturity.
Ten-year yields are being held down by investors seeking the most secure assets, Katayama said. The Fed meeting, an OPEC gathering, a U.K. referendum on whether Britain should stay in the European Union and an election in Spain may all provide reason to seek safety next month, he said.
“The market is preparing for June,” Katayama said. “There are so many events. There is considerable pressure for a risk-off scenario” that would fuel demand for the haven of Treasuries, he said. Katayama said he’s betting the two- to 10-year spread will keep shrinking.