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Bond Report: 2-year Treasury yield hits highest level in over a decade after CPI data dashes hopes for inflation peak

Yields on 2- and 10-year Treasury notes hit their highest levels in years on Friday, while part of the curve inverted, after data showing the U.S. inflation rate rose to 8.6% in May with few signs of peaking.

The spread between 5- and 30-year yields narrowed to minus 6 basis points, as yields on maturities from one to seven years out rose by a whopping 16 to 23 basis each. Meanwhile, fed-funds futures traders boosted the chances of a 75 basis point hike by the Federal Reserve next week and some analysts warned the central bank has lost control of inflation.

What yields are doing

The 2-year Treasury yield BX:TMUBMUSD02Y rose 23.2 basis points to 3.047% from 2.815% Thursday afternoon. That’s the highest 3 p.m. level since Dec. 31, 2007, according to Dow Jones Market Data. For the week, the rate soared 38 basis points, the biggest one-week gain since June 13, 2008.

The yield on the 10-year Treasury note
TMUBMUSD10Y,
3.158%

rose 11.5 basis points to 3.156% from 3.041% at 3 p.m. Eastern on Thursday. That’s the highest since Nov. 9, 2018. For the week, it was up 20.1 basis points.

The yield on the 30-year Treasury bond
TMUBMUSD30Y,
3.192%

was up 2.5 basis points at 3.195% after factoring in reopening levels. It rose 8.3 basis points this week.

What’s driving the market

Data released on Friday showed the headline annual rate of U.S. inflation rose to 8.6% in May, exceeding economists’ and traders’ estimates, from 8.3% the prior month. Rising rents, gas and food prices were among the components that led to the rise. Meanwhile, the cost of living jumped 1% on a monthly basis in May, also exceeding estimates.

See: Rising rents, gas and food prices push U.S. inflation rate to 8.6%, CPI shows

The report prompted fed funds futures traders to boost the chance of a 75 basis point increase by the Fed next week to 21% from 3.6% on Thursday, according to the CME FedWatch Tool. Economists at Barclays 
BARC,
-3.69%

and Jefferies backed up the shifting expectations, by indicating they expect policy makers to deliver a hike of that magnitude at their June 14-15 meeting.

Policy makers, who began shrinking the Fed’s balance sheet this month, raised the fed-funds rate by 25 basis points, or a quarter of a percentage point, in March, followed by a half-point rise in May. Fed Chair Jerome Powell has said half-point hikes are on the table this month and in July.

On Thursday, the European Central Bank signaled it will end its quantitative easing program on July 1 and likely deliver a quarter-point rate increase next month. The ECB also left the door open to larger rate increase in September.

See also: ECB could hike 50 basis points in September, says central bank’s Holzmann in first comments after meeting: report

What analysts say

“Friday’s inflation data suggests the ‘peak inflation’ debate may be premature,” said Nancy Davis, founder of Quadratic Capital Management.

“Investors remain too confident that the Federal Reserve will be able to control inflation,” Davis said by email. “We should not take the Fed’s ability to control inflation as a given.”

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