By Min Zeng 

Investors are clearing their calendars for a summer interest-rate increase.

Wagers on rising U.S. rates last week hit their highest level since 2014, according to a report from TD Securities on eurodollar futures trading. A separate market, for federal-funds futures, is now pricing in a 58% likelihood of a Federal Reserve rate move at July's policy meeting, up from 28% a month ago, according to CME Group data.

The data mark a profound shift from the market's mindset as recently as a month ago. Then, few investors expected the Fed to press the button this summer, reflecting lingering anxiety from the early-2016 swoon in stocks, commodities and bond yields.

But many investors have since changed their minds, thanks to continued signs of steady U.S. growth, a placid period overseas and increasing signals from the Fed that officials intend to keep gradually raising interest rates, brushing off skeptics who warn that the central bank risks cooling a tepid recovery by moving prematurely.

Some analysts and portfolio managers accelerated their rate-increase timetables after seeing the minutes for the Fed's April policy meeting, released on May 18, and hearing comments from Chairwoman Janet Yellen, Federal Reserve Bank of New York President William Dudley and a handful of others.

Ms. Yellen said Friday a rate increase would be appropriate "probably in the coming months" if the economy and labor market continue to strengthen.

"It is clear the Fed would like to hike rates this summer," said Kam Poon, a portfolio manager specializing in short-term debt instruments at Aberdeen Asset Management, which had $420.9 billion in assets under management at the end of March.

Mr. Poon said he sold Treasury securities following the release of the minutes of the Fed's April policy meeting, reflecting expectations that the central bank will tighten policy before September.

The value of net shorts in the eurodollar-futures market, reflecting expected interest rates on dollars held in banks overseas at a certain date, reached $730 billion for the week ending May 24, said Cheng Chen, U.S. rates strategist at TD Securities, citing data from the Commodity Futures Trading Commission. That is the largest net short since December 2014.

Eurodollar futures are a popular tool for investors seeking to hedge against rising rates or to speculate on the path and timing of Fed policy. As short-term yields rise, the contract price declines, benefiting those making short bets.

The fed-funds futures market showed on Tuesday that the odds of a rate increase at the Fed's June meeting were 23%, according to data from CME Group, down from 34% earlier in May.

The Fed hasn't raised rates unless the market assigned at least 60% odds to such a move via the near-term fed-funds futures contracts the day before a rate increase, according to Mark Cabana, U.S. rates strategist at Bank of America Merrill Lynch in New York. Mr. Cabana used fed-funds futures data back to 1994.

The ripples from the expected rate rise so far have been limited. Gold for August delivery closed up 0.1% at $1,217.50 a troy ounce on the Comex division of the New York Mercantile Exchange.

U.S. stocks have strengthened since the release of the Fed minutes, trading near their all-time high set in 2015. U.S. crude-oil prices hover around $50 a barrel, up nearly 90% from their 2016 low in mid-February.

U.S. government bond yields have risen modestly as investors shed interest-rate exposure, but yield increases have been largely limited to short-term debt.

The yield on the benchmark 10-year note closed at 1.834% Tuesday, only a bit higher than 1.821% at the end of April. Yields rise as bond prices fall.

Any Fed interest-rate increase is apt to set off market ripples as investors reposition themselves, said Jeff Greenberg, director and macro strategist at UBS Securities LLC.

"If there's increasing calm and complacency in markets, then there's also increasing vulnerability to shocks," he said.

Investors, however, don't expect a big rise in bond yields. The Bank of America Merrill Lynch MOVE index of options-based Treasury bond volatility, settled at 66.76 Friday, down from a recent high of 97.94 on Feb. 11. Rising rates often are welcomed as a sign of gathering economic strength.

"A rate hike would suggest Fed officials are confident that the U.S. economy is doing better," said Charles Comiskey, head of Treasury trading at Bank of Nova Scotia in New York.

Write to Min Zeng at min.zeng@wsj.com

 

(END) Dow Jones Newswires

May 31, 2016 20:01 ET (00:01 GMT)

Copyright (c) 2016 Dow Jones & Company, Inc.
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