US Treasuries vulnerable to short-term selling pressure on Fed members' hawkish comments

Federal Open Market Committee (FOMC) prepares for a critical interest rate decision in three weeks. FOMC minutes from the April meeting released last week opened the door to a rate hike in June, roiling financial markets. Fed is very adamant not to surprise markets and FOMC members are trying to prepare markets for an imminent rate hike by the Fed. Minutes os the April meeting revealed a divided committee and hence markets will keenly watch any comments from fed members on clues regarding the next hike. 

The influential William Dudley said last week that assuming incoming data continued meet expectations, a hike in June or July was a reasonable expectation. Philadelphia Fed President Patrick Harker said on Monday that he could see two to three rate increases this year, echoing similar remarks by San Francisco Fed’s John Williams. St. Louis Federal Reserve President James Bullard also said a relatively tight labor market may put upward pressure on inflation, raising the case for higher interest rates. 

Data (e.g. retail sales, CPI, IP growth) released since the meeting have been consistent with strong growth in Q2, and hence raise the risks for the move by the Fed in June. US retail sales rose 1.3 percent in April vs. 0.8 increase expected. U.S. consumer prices recorded their biggest increase in more than three years in April, pointing to a steady inflation build-up that could give the Fed ammunition to hike. U.S. manufacturing output rose 0.3 percent in April, a sign that the country's manufacturing sector was resisting the downward pull from sputtering global growth.

"We still think a rate rise next month is, on balance, unlikely – particularly given the proximity of the next Fed meeting to the UK’s EU referendum. Nevertheless, with recent US data pointing to a pick-up in US inflation and a decent bounce in Q2 economic activity, a move cannot be ruled out." said Lloyds Bank in a report.

Fed chair Janet Yellen will close the week with a speech at the Radcliffe Institute for Advanced Study at Harvard University. If the Fed wants to keep a June hike a real possibility, Yellen will have to try to guide markets to price in a higher probability in her speech on Friday. Post hawkish comments, the market pricing has shifted to a probability of a third for the June meeting, rising to around a half for the July meeting. Fed fund futures are indicating for the first time since March a 54 percent chance that the Federal Open Market Committee will raise interest rates by its July meeting. 

"Pricing of June hike still too low for the meeting to be truly ‘live’. If the Fed really wants to keep June a real possibility, market pricing needs to shift further. Fed outlook leaves bonds vulnerable to short-term selling pressure." notes Nordea Bank in e report. 

The U.S. Treasuries were little changed on Tuesday during a relatively quiet session that saw little data of much significance. The yield on the benchmark 10-year Treasury note hovered at 1.842 pct and the yield on the short-term 2-year bonds also remained unchanged at 0.909 percent by 1040 GMT.