Bond Report: 2-year Treasury yield hits highest in almost two years, 10-year falls to lowest in week with inflation at almost 40-year high

The two-year Treasury yield climbed to its highest in almost two years, while the 10-year rate dropped to the lowest in a week, following a $36 billion 10-year note auction that came off without much of a hitch, while data showed inflation rising to an almost four-decade high of 7%, or a bit below traders’ expectations.

The auction cleared “with little strain,” according to Jim Vogel of FHN Financial. Meanwhile, the spread between 2- and 10-year rates shrunk to 84 basis points and one part of the Treasury curve remained on the brink of an inversion.

What are yields doing?

The yield on the 10-year Treasury note TMUBMUSD10Y, 1.736% declined 2.1 basis points to 1.724% from 1.745% on Tuesday at 3 p.m. Eastern Time. Yields rise as bond prices fall. It’s the lowest level since Jan. 5.
The 2-year Treasury note TMUBMUSD02Y, 0.906% rate rose less than 1 basis point to 0.905%, up from 0.897% a day ago. That’s the highest since Feb. 27, 2020. The yield is up four of the past six trading days.
The 30-year Treasury bond rate TMUBMUSD30Y, 2.085% marginally declined to 2.071%, down slightly from 2.072% on Tuesday afternoon.
The 7-year Treasury note TMUBMUSD07Y, 1.672% was yielding 1.673%, down from around 1.691 % on Tuesday, FactSet data show.
The spread between 7- and 10-year rates continued to be on the verge of inversion.

What’s driving the market?

Consumer prices rose 0.5% in December to push the increase in the cost of living last year to an almost 40-year high of 7%, with inflation soaring due to strong customer demand and labor and supply shortages.

The monthly gain in the consumer-price index exceeded the 0.4% forecast of economists polled by The Wall Street Journal, though the 7% year-over-year figure came in a few basis points below the 7.03% anticipated by traders earlier this week. It was the third straight month in which the year-over-year gain exceeded 6%.

The data puts greater pressure on the Federal Reserve to start hiking the fed-funds rate target from its current level between zero and 0.25%, and to begin shrinking the central bank’s more than $8 trillion balance sheet. On Wednesday, one policy maker, Cleveland Fed President Loretta Mester, said she backs the process of shrinking the balance sheet “as fast as we can,” without pushing markets off track.

Rex Nutting: Why interest rates aren’t really the right tool to control inflation

The odds of a 25 basis point hike by the Fed in March hovered around 79% on Wednesday, while traders also continued to factor in the prospect of more than four rate increases in 2022, according to the CME FedWatch Tool.

Read: Here’s how the Federal Reserve may shrink its $8.77 trillion balance sheet to combat high inflation, according to a former Fed staffer

A separate inflation reading, measuring producer prices, is scheduled for 8:30 a.m. Eastern time on Thursday.

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What analysts are saying

“A lot of traders were set up for the annual CPI rate to be even higher than it was,” Tom Graff, head of fixed income for Brown Advisory in Baltimore, said via phone. “Everybody priced in this level of CPI and then some.” Meanwhile, bonds had been “oversold” ahead of the data, creating a lack of selling pressure after the report was released, which then turned into a bit of a “minor relief rally” during the New York morning.
“When the annual rate of inflation begins with a 7, there is immense pressure on the Federal Reserve to get it under control, supply chain issues notwithstanding,” Greg McBride, chief financial analyst at Bankrate, wrote in a note. “Both interest rate increases and not only stopping bond purchases but shrinking their balance sheet altogether are in the cards, and are likely to begin as soon as March.”

See: Fed has to be ‘far more aggressive…than the Street thinks,’ says academic who called Dow 20,000: ‘This is too much money chasing too few goods’

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