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Bond Report: Two-year Treasury yield at highest since 2008 after Fed talks tough

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Short-duration bond yields moved to fresh multi-year highs on Thursday as traders priced in the prospect of a resolutely hawkish Fed.

What’s happening

The yield on the 2-year Treasury
TMUBMUSD02Y,
4.100%

rose 6.5 basis points to 4.105%. Yields move in the opposite direction to prices.

The yield on the 10-year Treasury
TMUBMUSD10Y,
3.534%

added 1.1 basis points to 3.542%.

The yield on the 30-year Treasury
TMUBMUSD30Y,
3.478%

dipped 2 basis points to 3.484%.

What’s driving markets

Investors remain wary of government debt after Wednesday’s rate hike by the Federal Reserve was accompanied by hawkish comments from Fed Chair Jerome Powell.

The 2-year Treasury yield climbed above 4.1%, its highest since the great financial crisis.

“While the 75-basis point rise in U.S. rates was largely expected, particularly after U.S. inflation proved stickier than hoped in August, the messaging around the decision helped put markets in a tizz,” said Russ Mould, AJ Bell investment director.

“Powell, like a sawbones of yesteryear warning a patient the leg will have to come off to prevent the spread of gangrene, noted there was no painless way to bring inflation under control,” Mould added.

Markets are pricing in a 70% probability that the Fed will raise interest rates by yet another 75 basis points to a range of 3.75% to 4.00% after its meeting on November 2nd. The central bank is expected to take its Fed funds rate target to 4.63% by April 2023, according to the CME FedWatch tool.

Some observers are slightly more hawkish. “With Powell suggesting a high bar for slowing the pace of hikes, we now expect another 150 basis points on top of September’s 75bp hike, with the target range peaking at 4.50-4.75% in Q1 23,” said Jonathan Miller, economist at Barclays.

The upshot is that the market now reckons there is an increased chance that higher Fed funds rates will cause an economic slowdown.

This is shown by an even more steeply inverted yield curve. The policy-sensitive 2-year U.S. government bond yield has surged above 4% for the first time since 2008, while the 10-year Treasury yield actually finished Wednesday’s session lower. The current 10-2-year inversion of around 50 basis points is the deepest since 2000, according to Tradeweb.

U.S. economic updates set for release on Thursday, include the weekly jobless claims data and the current account deficit report, both due at 8:30 a.m. Eastern. The leading economic indicators report is published at 10 a.m.

Elsewhere, the yield on Japan’s 10-year note was down 1.6 basis points to 0.245% after the Bank of Japan left overnight rates unchanged at 0.1%, eschewing the tighter policy of its peers as it noted that inflation of 2.8% was mostly the result of high energy prices.

But other central banks continued to raise borrowing costs to combat rapid price pressures. Norway hiked by 50 basis points to 2.25% and Switzerland pushed rates up by 75 basis points to 0.5%.

U.K. 10-year gilt yields
TMBMKGB-10Y,
3.293%

dipped 2.9 basis points to 3.286% as traders waited to see if the Bank of England on Thursday at 7 a.m. would raise rates by 50 or 75 basis points.

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