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#Bond Report: Treasury yields edge higher as traders absorb latest Fed comments

“Bond Report: Treasury yields edge higher as traders absorb latest Fed comments”

U.S. bond yields inched higher on Tuesday as more hawkish rhetoric from the Federal Reserve counteracted signs of cooling inflation in Europe.

What’s happening
  • The yield on the 2-year Treasury
    TMUBMUSD02Y,
    4.483%
    advanced to 4.479%, up slightly from 4.469% on Monday.

  • The yield on the 10-year Treasury
    TMUBMUSD10Y,
    3.744%
    jumped to 3.741% from 3.701% as of Monday afternoon.

  • The yield on the 30-year Treasury
    TMUBMUSD30Y,
    3.778%
    was 3.786%, up from 3.748% late Monday.

What’s driving markets

Benchmark U.S. government bond yields moved up on Tuesday as investors continued to absorb the latest hawkish comments from Federal Reserve officials, who indicated that they’ll probably leave borrowing costs high for years to come.

St. Louis Fed President James Bullard said on Monday that the central bank will likely need to keep its benchmark interest rate above 5% for most of next year and into 2024 in order to cool inflation that running not far below 40-year highs.

Markets are pricing in a 67.5% probability that the Fed will raise its policy rate by 50 basis points to a range of 4.25% to 4.5% on Dec. 14, and a 32.5% chance of another 75-basis-point hike, according to the CME FedWatch tool. The central bank is mostly expected to take its fed-funds rate target to at least 4.75% to 5% by March.

In U.S. economic data on Tuesday, the S&P Case-Shiller 20-city U.S. home price index dropped 1.2% in September, its third consecutive monthly decline.

Helping suppress yields was better news on inflation from Europe. The German 10-year bund yield
TMBMKDE-10Y,
1.939%
fell 4.8 basis points to 1.947% after data showed Germany’s annual rate of inflation decelerated in November.

What analysts are saying

Bullard said “markets are under-pricing the risk that FOMC might be more aggressive and again referred to the output of his Taylor Rule model, saying that he thinks the Fed should get to the bottom of the 5-7% range. That is an extremely wide spread and markets are already pricing a terminal rate that reaches the bottom of that range,” Jan Nevruzi, John Briggs, and Brian Daingerfield of Nat West wrote in a note.

“We expect the Fed to remain on hold in 2023, but reduce rates sharply in 2024, ending the year near 2%, which is well below market pricing. From today’s vantage point, it is hard to imagine how the Fed could even entertain cuts, but if rates are at 5% (terminal) when inflation is in the 7-8% range, I don’t think it would be a problem for the Fed to cut towards neutral if inflation gets back to our forecast of ~2% in 2024 (or shows a strong trend in that direction),” they said.

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