Will GDP force Fed's hand? Treasuries say so

Treasuries fell after a report showed the economy grew faster than forecast in the second quarter, backing speculation the Federal Reserve will end its extraordinary stimulus policies and raise interest rates next year.

U.S. two-year note yields reached the highest level in more than three years as gross domestic product grew at a 4 percent annualized rate in the second quarter, the Commerce Department said, compared with the 3 percent rise projected in a Bloomberg News survey. Fed policy makers end a two-day meeting as traders see about a 52 percent chance the central will raise the target for its benchmark to at least 0.5 percent by June, based on futures contracts.

“Potentially, bond yields are a little bit too low,” said William Larkin, a money manager who oversees $520 million in assets at Cabot Money Management in Salem, Massachusetts. “That’s one of the things the bond market was counting on -- subpar growth.”

Benchmark 10-year yields rose four basis points, or 0.04 percentage point, to 2.50 percent at 9:05 a.m. in New York, according to Bloomberg Bond Trader data. The 2.5 percent securities maturing in May 2024 lost 11/32, or $3.44 per $1,000 face amount, to 30 31/32. The yield fell to 2.45 percent on July 17, the lowest level since May 29.

Two-year note yields gained three basis points to 0.57 percent, the most since May 19, 2011.

Economic watch

“Expectations were really high for a bounce back from the weakness of the first quarter and we are finally seeing the growth momentum,” said Christopher Sullivan, who oversees $2.3 billion as chief investment officer at United Nations Federal Credit Union in New York, before the report. “A better print will put further pressure on the front end of the curve as it brings forward the expectation for Fed tightening.”

The difference between yields on five-year notes and 30- year debt, known as the yield curve, narrowed to as little as 149 basis points, the least since January 2009. Shorter maturities are more sensitive to what the Fed does with interest rates, while longer-dated debt is more influenced by the outlook for inflation.

Treasuries fell earlier before the auctions of $15 billion of two-year floating rate notes and $29 billion of seven-year fixed-rate securities.

The Federal Open Market Committee releases its policy statement at 2 p.m. in Washington. Subdued inflation has given the Fed’s policy making committee room to keep the main interest rate near zero to encourage lending and spur growth.

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