Bond Report: 2-year Treasury yield hits 2-week high as investors factor in another half-point Fed rate hike for September

Yields on 2- through 7-year Treasury notes moved sharply higher on Wednesday, as traders priced in a 59% chance that the Federal Reserve will deliver yet another 50-basis-point rate hike in September.

What yields are doing

The 2-year Treasury note yield BX:TMUBMUSD02Y climbed 12.4 basis points to 2.664% from 2.54% Tuesday afternoon. That’s the largest one-day gain since May 18, based on 3 p.m. yields, according to Dow Jones Market Data.

The yield on the 10-year Treasury note

rose 8.8 basis points to 2.93% from 2.842% at 3 p.m. Eastern on Tuesday.

The 30-year Treasury bond yield

rose 1.9 basis points to 3.075% versus 3.056% late Tuesday.

Wednesday’s levels are the highest for the 10- and 30-year rates since May 17.

What’s driving the market

Front-end and intermediate Treasury yields rose steeply as investors reassessed their expectations for the path of the Fed’s interest rate policy, with hopes for either a pause in rate increases or 25-basis point hike in September slipping away.

On Wednesday, St. Louis Fed President James Bullard said the Fed is “on the precipice of losing control of inflation expectations,” and needs to take credible action to keep expectations low and stable. Meanwhile, his colleague, San Francisco Fed President Mary Daly, said in an interview with CNBC that the time to pause is when the Fed gets its benchmark policy rate target up to about 2.5%.

Investors remain concerned that inflation continues to run at a hot pace, while also worrying about the Federal Reserve’s ability to get price pressures under control without sinking the economy. The Fed raised its key interest rate by a larger-than-usual increment of 50 basis points, or half a percentage point, in May. Fed Chair Jerome Powell has said that half-point moves are on the table at the central bank’s next two policy meetings in June and July.

Meanwhile, the Fed kicked off the process known as quantitative tightening, which entails reducing the size of its nearly $9 trillion balance sheet, as of Wednesday.

See: Fed to begin quantitative tightening: What that means for financial markets

In data released Wednesday, S&P Global’s final purchasing managers index reading for the U.S. manufacturing sector slipped to 57.0 in May versus a 57.5 flash estimate, while the Institute for Supply Management’s manufacturing index rose to 56.1% in May from 55.4% in the prior month. U.S. job openings fell to 11.4 million in April from a record 11.9 million in the prior month, while some 4.4 million workers quit jobs. The job-quitting rate was unchanged at 2.9%.

Outside the U.S., the Bank of Canada raised its target on the overnight rate by 50 basis points for a second straight time, to 1.5%, and said it is prepared to act more forcefully if needed to meet its 2% inflation target.

What analysts say

Treasurys sold off on Wednesday “in a rather dramatic fashion,” said Ian Lyngen and Benjamin Jeffery, rates strategists at BMO Capital Markets, in a note.

“The move was in response to stronger ISM data and the Bank of Canada’s half-point hike that was accompanied by hawkish rhetoric that left open the possibility of a 75 bp increase in the event inflation doesn’t moderate. U.S. rates typically don’t respond directly to the nuances of other central banks’ forward guidance; these are unique times if nothing else,” they wrote.

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