Why JPMorgan Sees September Liftoff But Cut Bond Yield Forecasts

JPMorgan Chase & Co. is cutting Treasury yield forecasts even as it stands by its call for a first Federal Reserve interest rate rise in September.

The reason: Oil. The bank’s analysts expect a tumble in energy prices to weigh down inflation expectations, supporting demand for longer-term debt.

That’s even as it continues to predict short-term yields will nearly double this year, with a U.S. jobs report Friday encouraging traders to raise bets on higher borrowing costs next month to above 50 percent. The gap between two- and 30-year yields -- known as the yield curve -- was near the narrowest since April.

“Global demand for longer-term Treasuries remains strong and inflation expectations remain muted,” JPMorgan Chase & Co. analysts including Jay Barry, Bruce Sun and Phoebe White wrote in a report dated Aug. 7. “We continue to view short-term yields as underestimating both the timing and pace of the coming Fed rate hikes.”

The benchmark 10-year note yield climbed two basis points, or 0.02 percentage point, to 2.18 percent as of 7:19 a.m. in London, after declining for four straight weeks, Bloomberg Bond Trader data show.

The 2.125 percent security due in May 2025 fell 6/32, or $1.88 per $1,000 face amount, to 99 15/32. The yield reached 2.14 percent on Aug. 3, a two-month low.

Two-year Treasuries yielded 0.73 percent compared with 2.83 percent for 30-year securities.The premium on long bonds was 210 basis points, near the 209 reached Friday that was the narrowest since April 28.

September Liftoff?

Swaps traders see 56 percent odds of September liftoff -- compared with 40 percent at the end of last month -- after data showed U.S. employers added more than 200,000 jobs for a third straight month in July.

JPMorgan lowered its year-end forecast for 10-year yields to 2.50 percent from 2.55 percent, while holding predictions for two-year notes at 1.25 percent. The bank’s strategists slashed 2015 Brent crude oil estimates to $50 per barrel from $67.

The commodity traded at about $48 on Monday, from near $116 in June of last year. Five-year Treasury market inflation expectations -- known as the break-even rate -- slumped to the lowest since January at 1.29 percent.

“I don’t expect a big rise in the inflation rate,” said Kazuyuki Takigawa, who manages about $6 billion of bonds as the chief fund investor for foreign fixed income at Resona Bank Ltd. in Tokyo.

 “It seems very clear that the Fed will start tightening in September for the first time in many years. We will see another big leg up in short-term rates, leading to a further flattening of the yield curve.”

The two-year yield could rise as high as 0.88 percent in the near term, he said.

bloomberg.com