As Fed meets, something's 'amiss' in bond market

Looking at the bond market in the past week, it might appear from the rising yields that the Fed is getting close to hiking rates.

The 10-year Treasury note yield was as high as 1.93 percent Tuesday, up from 1.78 percent a week ago. The 2-year note yield rose to 0.86 percent, from 0.76 percent last week.

But the view on Wall Street does not reflect these rising yields. Many economists say the Fed is still months away from a rate hike, and fed funds futures show low expectations for a hike this year. Add to that the economic data lately have been softer than expected.

"Something's amiss here. Something doesn't fit," said David Ader, chief Treasury strategist at CRT Capital.

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Ader put together a chart that shows that yields have risen even as the Citigroup Economic Surprise Index showed an increase in negative surprises, opposite the trend that would be expected. In fact, charting the surprise index over the 10-year Treasury yield shows a stunning divergence.

Ader said the real reason the market is moving is because of trader positioning rather than in response to Tuesday's economic data, which was weak and would have sent yields lower.

Ader said traders fear there's an outside chance the Fed could act sooner than expected because of the comments from the more hawkish Fed officials. Some strategists say the market sees a risk that the Fed would signal a June hike in its statement.

"We also have what's going on overseas," said Ader. U.S. rates have been influenced by German bund yields which moved from 0.16 percent to 0.29 percent in just a week.

Tom Simons, money market economist at Jefferies, said bond traders are also afraid of getting burned when the Fed releases its post meeting statement Wednesday afternoon. "There is a risk because communications have been somewhat erratic," said Simons.

"It's just that there's always a risk that the market interprets something that isn't there with the Fed. I think what we've seen from the Fed over a long period of time now is there are times when they struggle with communications," he said. "Even if you think they're not meaning to be hawkish tomorrow, there' always the risk of volatility. ...There's just a little bit of nervousness ahead of tomorrow."