Inflation fears drive US bond yields higher ahead of Fed meeting

U.S. government bond yields closed Monday at their highest levels in more than a decade, propelled by fears that persistent inflation could push the Federal Reserve to raise interest rates even higher and faster. provided that.

The yield on the benchmark 10-year Treasury note stood at 3.371%, according to Tradeweb, its highest close since April 2011 and up from 3.156% on Friday. The two-year Treasury yield — which often rises with expectations of Fed rate hikes — rose to 3.279%, a new 15-year high, from 3.047% on Friday.

The surge in after-hours bond trading, which took the 10-year yield briefly above 3.4%, following a Wall Street Journal report that Fed officials were likely to consider raising interest rates 0.75 percentage points higher than expected this week to fight inflation. Friday’s data showed consumer prices rose at an annual rate of 8.6% in May, putting inflation at its fastest pace since the 1980s, despite measures the Fed has already taken to cool the economy.

Traders quickly raised their expectations for the magnitude of the Fed’s next interest rate move. Late Monday, federal funds futures, used by traders to bet on central bank policy, showed a roughly 28% chance that authorities would raise rates by 0.75 percentage points this week. , up from around 3% a week ago.

The inflation reading also boosted expectations for the Fed’s benchmark rate hike. Investors now expect officials to hike rates to nearly 4% by next spring, from the expected peak of around 3% last month.

Fed officials have signaled that raising interest rates to bring inflation down is their top priority. The central bank’s 0.5 percentage point rate hike at its May meeting — after a smaller increase in March — was already the most aggressive rate hike the Fed has made in more than 20 years.

On the other hand, an even faster rate hike would challenge previous central bank guidance, and some analysts have said it will be harder for the Fed to monitor the effects of tighter monetary policy, which is essential to help policy makers avoid tipping the economy into a recession.

Going too fast would be “like looking in your rearview mirror and realizing you missed your exit,” said Gennadiy Goldberg, senior U.S. rates strategist at TD Securities.

Treasury yields had already soared this year as rising inflation quickly changed traders’ expectations of Fed policy. The rise in the 10-year yield rattled US equity valuations, sending major indexes tumbling. Higher yields on ultra-safe bonds diminish the appeal of riskier Wall Street bets.

On Monday, the S&P 500 fell 3.9%, a decline that sent the index into bear territory, defined as a 20% drop from a recent high. The tech-heavy Nasdaq Composite fell 4.7%.

In another sign of bond traders’ concerns, the sale of new, short-term Treasury debt yielded some of the weakest results in years. Monday’s auction of new three-month bills ended with a yield 0.09 percentage point above traders’ expectations, the biggest difference since September 2008, when markets were rocked by the financial crisis world, according to analysts at Jefferies.

Rising Treasury yields raise costs for borrowers across the economy, from businesses to homebuyers. Corporate bond yields have risen this year even more than Treasury yields as investors demand higher premiums to lend money to companies. Residential mortgage rates have also surged, hitting their highest level since 2009 last month. Local governments are issuing fewer new bonds, investors are becoming more discerning about buying specialty debt securities and the booming real estate market is showing signs of improvement. signs of slowing down.

Although concerns are growing about how rising rates will affect economic growth, high inflation could force the Fed’s hand, some analysts said.

“Fed officials who very recently expressed hope that inflation would ease over the course of the year will now face an accelerating price backdrop despite rapidly tightening financial conditions,” the economists wrote. of Citigroup.

Write to Matt Grossman at [email protected]

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