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Bond Report: Short-term bond yields rise as traders absorb hawkish Fed rhetoric

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Bond yields rose on Thursday as investors increased bets on a 50 basis point rate hike at the the next Fed meeting.

What’s happening

The yield on the 2-year Treasury
TMUBMUSD02Y,
4.386%

rose 3.7 basis points to 4.383%. Yields move in the opposite direction to prices.

The yield on the 10-year Treasury
TMUBMUSD10Y,
3.693%

added 1.4 basis points to 3.700%.

The yield on the 30-year Treasury
TMUBMUSD30Y,
3.798%

was barely changed at 3.801%.

What’s driving markets

The International Monetary Fund has backed up the Federal Reserve’s hawkish stance, with Gita Gopinath, the Fund’s second-in-command, telling the Financial Times that U.S. inflation had “not turned the corner yet” and the central bank should “stay the course” in its battle to damp inflation.

Minutes from the Fed’s December rate-setting meeting, published Wednesday, showed participants appeared more concerned about easing financial conditions too soon than keeping policy restrictive for too long.

Markets are pricing in a 64.2% probability that the Fed will raise interest rates by another 25 basis points to a range of 4.50% to 4.75% after its meeting on February 1st, and displaying a 35.8% chance of a 50 basis point rise to 4.75% to 5%, according to the CME FedWatch tool.

For a number of weeks the chances of a 50 basis point hike had been priced at around 26%, so the shift higher points to traders becoming more concerned that the Fed’s hawkish rhetoric may translate into a bigger rate rise than previously thought.

The central bank is expected to take its Fed funds rate target to 5.0% by June 2023, according to 30-day Fed Funds futures.

Economic data due on Thursday include the ADP private sector employment survey for December, published at 8:15 a.m. and the weekly initial jobless claims numbers at 8:30 a.m. Eastern. The S&P U.S. services PMI index will be released at 9:45 a.m.

St Louis Fed President James Bullard is due to speak at 1:10 p.m.

What are analysts saying

“The Fed believes monetary policy works through financial conditions. With that in mind, the 50bp drop in 10-year yields since early November is problematic,” said Chris Low, chief economist at FHN Financial.

“Still, it is also worth noting a 20bp increase in 10-year yields since the December Fed announcement. Market conditions remain easier than they were at the November meeting — and the Fed was worried about conditions between the November and December meetings — but they have tightened some since this comment was made on December 14.”

“Otherwise, there is the same observation of a tight labor market and ‘need’ to slow the economy to prevent a wage-price spiral as explained by Chair Powell on the day of the meeting. The economy is too hot and it is the Fed’s responsibility to cool it down. These minutes imply the Fed will have to do more if the market does not cooperate,” Low concluded.

: IMF’s Golpinath backs up Fed’s tough stance

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