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Bond Report: Treasury yields post biggest one-day gains in a week, curve briefly flattens after Federal Reserve pencils in three hikes for 2022

Treasury yields posted their biggest one-day gains in a week Wednesday after Federal Reserve policy makerspenciled in three interest rate increases for 2022 and agreed to more quickly wind down monthly bond purchases.

Meanwhile, the Treasury yield curve briefly flattened soon after the Fed’s policy update. The 2s-10s spread narrowed to as low as 74 basis points, while the 5s-30s gap flattened below 55 basis points.

What are yields doing?

The yield on the 10-year Treasury note
TMUBMUSD10Y,
1.454%

rose 2.3 basis points to 1.460%, up from 1.437% at 3 p.m. Eastern on Tuesday.

The 2-year Treasury yield advanced 2.6 basis points to 0.683%, compared with 0.657% late Tuesday.

The 30-year Treasury bond
TMUBMUSD30Y,
1.865%

rose 3.3 basis points to 1.851%, up from 1.818%.

It was the largest one-day gains for the 10- and 30-year rates since Dec. 8, and the biggest gain for the 2-year yield since Dec. 7, based on 3 p.m. levels, according to Dow Jones Market Data.

What’s driving the market?

As widely expected, Fed officials on Wednesday agreed to cut back on their monthly asset purchases more quickly by doubling the reduction to $30 billion a month.

Policy makers also penciled in three interest rate increases for next year in their so-called dot plot, while keeping their long-run projection for the fed funds rate at 2.5% and raising their inflation forecasts through 2023.

During a press conference Wednesday, Fed Chairman Jerome Powell said that the central bank would use its tools to prevent persistently elevated inflation from becoming entrenched, and that a return to a higher workforce participation rate may take “some time.”

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Earlier on Wednesday, government data showed that U.S. retail sales climbed a tepid 0.3% in November, less than the 0.8% rise expected by economists polled by The Wall Street Journal. Meanwhile, the U.S. import price index jumped 0.7% last month, contributing to the highest rate of U.S. inflation in almost 40 years.

The New York Fed’s Empire State business conditions index rose 1 point to 31.9 in December. Economists had expected a reading of 25, according to a survey by The Wall Street Journal. 

And home builders grew more confident for the fourth consecutive month, according to an industry index. The National Association of Home Builders’ monthly confidence index rose one point to a reading of 84 in December, the trade group said Wednesday. That represents the highest level for the index since February.

In Washington politics, Congress signed off early Wednesday on a debt-limit increase, acting ahead of a key deadline to avoid an unprecedented default. The Senate and House approved a bill raising the debt limit by $2.5 trillion, sending the legislation to President Joe Biden for signature.

What are analysts saying?

“As expected, the Fed doubled the pace of tapering with the end date now in March,” said Jason England, global bonds portfolio manager at Janus Henderson Investors.  “This gives the Fed flexibility with their next step in removing accommodation, which is liftoff with rate hikes.”

The front-end of the US Treasury curve should see pressure, “leading to more flattening with the trajectory of front-end rates higher,” England said.

“The flattening yield curve seems to suggest that the bond market is not exactly seeing a path for the fed funds rate to go back to the 2-2.5% range,” said Anu Gaggar, global investment strategist for Commonwealth Financial Network. “The bond market seems to believe that the Fed will likely have to level off at a much lower rate than that as economic growth might begin to slow down.”

Read: The risk of a broader inversion in the Treasury yield curve is on the radar heading into 2022

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