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Bond Report: Two-year Treasury yield hits highest since 2007 as Powell comments reverberate

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Bond yields rose on Thursday to new cycle highs as the fallout from the Federal Reserve’s latest rate hike and commentary continued to reverberate across markets.

What’s happening

The yield on the 2-year Treasury
TMUBMUSD02Y,
4.732%

rose 10 basis points to 4.708%. Yields move in the opposite direction to prices.

The yield on the 10-year Treasury
TMUBMUSD10Y,
4.200%

added 12.8 basis points to 4.185%.

The yield on the 30-year Treasury
TMUBMUSD30Y,
4.211%

climbed 6.4 basis points to 4.204%.

What’s driving markets

Bond yields were higher as investors continued to parse the previous day’s Federal Reserve monetary policy announcement. The central bank raised interest rates by 75 basis points to a range of 3.75% to 4%, and comments by Chair Jerome Powell were considered more hawkish than expected.

The policy-sensitive 2-year Treasury yield moved above 4.7%, its highest since the summer of 2007.

“U.S. Treasury yields higher again this morning – up 4-6bps across the curve to be about 10bps (or more) higher from this time yesterday – after Jay Powell yesterday made clear in his post-FOMC press conference that the terminal fed funds rate for the current hiking cycle is likely to be higher than previously suggested by the Fed’s dot-plot,” said Emily Nicol, economist at Daiwa Capital Markets, in an early morning note.

“Powell also insisted again that the FOMC planned to remain restrictive ‘for some time,’ and reiterated that he judged the risks of tightening insufficiently to be greater than the risks of tightening too much,” Nicol added.

Andrew Hollenhorst, economist at Citi, said: “The overall takeaway from the FOMC is hawkish with Chair Powell explicitly stating he would prefer to overtighten, and have to subsequently back off, than to under-tighten and potentially let inflation get out of control.”

Changes to the statement indicated the Fed had a strong preference to slow the pace of rate hikes, but it may continue to tighten for longer, taking rates to levels higher than considered in September.

“We are revising up our expectations for Fed policy rates and project a 50bp hike in December, another 50bp in February, 25bp in March, and a final 25bp May resulting in a terminal rate of 5.25-5.50%,” Hollenhorst wrote in a note to clients.

Markets are pricing in a 62% probability that the Fed will raise interest rates by another 50 basis points to a range of 4.25% to 4.50% after its meeting on December 14th. The central bank is expected to take its Fed funds rate target to 5.1% by June 2023, according to the CME FedWatch tool.

U.S. economic updates set for release on Thursday include weekly initial jobless claims, foreign trade deficit data for September, and third quarter productivity numbers, all at 8:30 a.m. Eastern. The ISM services index for October and September factory orders reports will be published at 10 a.m.

Meanwhile, over in the U.K. the 10-year gilt yield
TMBMKGB-10Y,
3.487%

rose 4.4 basis points to 3.443% as traders waited for the Bank of England’s latest monetary policy decision, due at noon GMT (8 a.m. Eastern). The BoE is expected to raise rates by 75 basis points to 3% as it battles inflation running at a 40-year high of 10.1%.

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