Treasuries Have Banner Day on Signs Fed Rate Hikes May Be Done

Treasury yields posted some of their their biggest single-day declines all year on expectations that the Federal Reserve is likely done raising interest rates.

(Bloomberg) — Treasury yields posted some of their their biggest single-day declines all year on expectations that the Federal Reserve is likely done raising interest rates.

US 10-year yields slid more than 18 basis points to 4.62% at one stage Tuesday, a day after two Fed officials expressed the idea that the recent surge in US yields may have done some of the job of tightening financial conditions for them. It was down about 15 basis points at 3 p.m. New York time. The cash market was closed for a public holiday on Monday.

The Fed speakers “seemed very much on the same page in noting higher bond yields and tighter financial conditions will impact their thinking on the Fed funds rate,” said Andrew Ticehurst, a rates strategist at Nomura Holdings Inc. in Sydney. “Market pricing suggests the Fed likely won’t hike this year,” he said, adding there may still be a risk of a final “insurance” increase. 

Fed Vice Chair Philip Jefferson said he’s watching the increase in Treasury yields as a potential further restraint on the economy even though the rate of inflation remains too high. Fellow policymaker Lorie Logan said the recent increase in long-term yields may indicate less need for the central bank to raise rates again. 

Meeting-dated swaps now show about a 60% chance the Fed will stay on hold in December, compared with 60% odds on another hike by then, just a week ago. 

The move in Treasuries was compounded by haven demand amid jitters over the Israel-Hamas conflict and Monday’s market closure.

Yields on short-dated gilts also declined. German bonds, in the meantime, fell as traders pared bets on interest-rate cuts from the European Central Bank next year. The two-year rate climbed 4 basis points to 3.06% after dropping nine basis points yesterday. 

ECB Governing Council member Francois Villeroy de Galhau said on Tuesday there’s no justification at present to resume monetary tightening amid a clear downtrend in inflation. 


Still, bond investors have had their hopes for an end to rate hikes dashed before. A rally after the banking crisis that sent 10-year yields as low as 3.25% in April was followed by waves of selling as the Fed kept on tightening policy. ECB’s Villeroy also stressed the need for vigilance on oil prices amid the Israel-Hamas conflict, which could stoke inflation expectations. 

With the ECB “recently stressing that not being forceful enough with rate hikes is more costly to the economy than being overly aggressive, it may decide an additional rate increase is needed and keep interest rates at that new level for longer,” said Frederique Carrier, head of investment strategy in the British Isles at RBC Wealth Management.

Treasury yields have surged in recent months amid concern stubborn inflation will convince the Fed to keep borrowing costs higher for longer. An index of US government debt has dropped 2.6% this year, heading for a third year of losses.

The Fed’s rate increases have so far failed to bring inflation back down to its 2% target, and the US economy still appears to be resilient. Yields have also risen this year on concern about increased Treasury issuance, which is needed to fund widening government deficits.

The recent run up in yields “might give the Fed extra reason for pause in the short run, but it’s too early to call this justification for the end of the cycle,” said Robert Thompson, macro rates strategist at Royal Bank of Canada in Sydney.

–With assistance from Alice Gledhill, Michael Mackenzie and Aline Oyamada.

(Updates yield levels.)

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