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Bond Report: 2-year Treasury yield ends week at December 2018 high as Fed officials move toward more quickly tightening policy

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The 2-year Treasury yield finished the week at its highest level in more than three years on Friday, a day after Federal Reserve Chairman Jerome Powell affirmed a half percentage point interest rate increase is on the table for May with possibly more to come in future meetings.

For the week, the 2-year yield, which is most closely associated with the path of Fed policy, posted its sixth rise in the past seven weeks.

What are yields doing?

The 2-year Treasury yield BX:TMUBMUSD02Y rose 2 basis points to 2.713% from 2.693% Thursday afternoon. That’s the highest since Dec. 14, 2018, based on 3 p.m. data from Dow Jones Market Data. The rate rose 27.1 basis points this week, the largest weekly gain since the period that ended March 25.

The yield on the 10-year Treasury note
TMUBMUSD10Y,
2.896%

fell 1.2 basis points to 2.905% from 2.917% at 3 p.m. Eastern on Thursday. It rose 9.7 basis points this week.

The yield on the 30-year Treasury bond
TMUBMUSD30Y,
2.945%

rose 1.1 basis points to 2.943% from 2.932% late Thursday. It rose 2.6 basis points this week and is up for three straight weeks.

What’s driving the market?

Traders continued to assess comments made by Federal Reserve policy makers such as Loretta Mester, president of the Fed’s regional bank in Cleveland, who said on Friday that she backs a 50 basis point hike in May “and a few more” to get the fed funds rate target to 2.5% by year-end.

Mester also said that the central bank wants tighter financial conditions, “but not necessarily all at once,” and that “we don’t need to go” to a 75 basis point hike. Her comments came after Thursday’s remarks by Fed Chairman Jerome Powell, who said “50 basis points will be on the table” at the May meeting.

A half percentage point hike in May, following a quarter percentage point point rise in March, would mark the first time that the Fed has increased interest rates in consecutive meetings since 2006. Currently, policy makers are attempting to combat an annual headline U.S. inflation rate that’s running at 8.5% as of March.

Read: Fed chief Powell backs moving more quickly on interest-rate hikes

In U.S. economic data, S&P Global’s preliminary purchasing managers index for the manufacturing sector rose to 59.7 in April from 58.8. Meanwhile, the services PMI dropped to 54.7 in April from 58.0. A reading of more than 50 still indicates growth in activity.

See: High inflation is sapping the U.S. economy, S&P finds, and customers are balking at higher prices

What are analysts saying?

Treasury yields “surged again on the idea of even more rate hikes, specifically that the Fed could hike 50 bps (basis points) in May, June and July,” said Tom Essaye, founder of Sevens Report Research, in a note.

“Bottom line, the Treasury market continues to play ‘catch up’ with expected rate hikes and now the market appears to pricing in 150 bps of hiking by the end of the July meeting, which is flattening the curve more. If the 10s-2s yield curve continues lower and re-inverts, that will reinforce the signal that the economy is likely headed for a future slowdown, one likely less than a year away,” he wrote.

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