Bond Report: 2-year Treasury yield carves out another almost 15-year high after August’s inflation surprise


The two-year Treasury yield reached another November 2007 high on Tuesday, after August’s consumer-price index dashed hopes for a meaningful slowdown in inflation and reinforced expectations that the Federal Reserve will continue to aggressively raise interest rates.

What’s happening
  • The yield on the 2-year Treasury TMUBMUSD02Y, 3.741% soared 18.3 basis points to 3.754% from 3.571% on Monday. That’s the largest one-day gain since Aug. 5 and the highest level for the yield since Nov. 1, 2007, based on 3 p.m. levels, according to Dow Jones Market Data.
  • The yield on the 10-year Treasury TMUBMUSD10Y, 3.418% rose 6.1 basis points to 3.422% from 3.361% late Monday. That’s the largest one-day jump since Sept. 6, and highest level for the yield since June 14.
  • The yield on the 30-year Treasury TMUBMUSD30Y, 3.492% declined less than 1 basis point to 3.506% from 3.513% Monday afternoon.
  • The 5-year TIPS or inflation-adjusted yield rose to 1.02%, the highest level since December 2018, from 0.955% on Monday, according to Tradeweb data. The 10-year TIPS yield rose to 0.975%, compared with Monday’s level of 0.948%, and reached the highest level since January 2019.
What’s driving markets

Tuesday’s consumer-price index report from the U.S. Labor Department took investors by surprise when it revealed that inflation had accelerated at a monthly rate of 0.1% in August, compared with the drop of 0.1% expected by economists polled by The Wall Street Journal. The annual headline inflation rate dropped to 8.3% from 8.5% in July, coming in above traders’ and economists’ expectations.

More troubling, though, were signs that inflation had spilled further into services, helping to push up the so-called core rate of inflation that omits food and energy prices by 0.6%, double the prior month’s increase. 

See: U.S. inflation slows again due to cheaper gas, CPI shows. But prices still high for almost everything else

Fed funds futures traders are now pricing in a 68% chance that the Federal Reserve raises its benchmark interest rate by 75 basis points next week, and a 32% chance of a 100 basis-point hike, according to the CME’s FedWatch tool.

Meanwhile, the Treasury yield curve went more deeply negative, with the spread between 2- and 10-year yields shrinking to minus 33 basis points in a worrisome sign about the outlook. Henry Allen, a research analyst at Deutsche Bank DB, -3.54%, the first major Wall Street bank to call a U.S. recession in the current inflationary environment, said a hard landing is still ahead for the U.S. economy.

See also: 4% fed funds rate ‘won’t be high enough,’ Jefferies economists say after August CPI report and Pimco economists see fed funds rate getting to 4.5%, call August CPI report ‘scorching’

In other bond-market news, Treasury’s $18 billion 30-year bond reopening produced “another very strong buyside showing,” said Jefferies economists Thomas Simons and Aneta Markowska.

What analysts are saying

“While this morning’s report may serve to solidify next week’s increase at 75bps, it does little to change the underlying dilemma for a Fed frantic to rein in price pressures, much of which are out of its control,” said economist Lindsey Piegza and analyst Lauren Henderson of Stifel, Nicolaus & Co. “With traditional policy metrics less effective in fighting supply-side price pressures, the [Federal Open Market] Committee is increasingly likely to unnecessarily tighten the U.S. economy into recession in a desperate attempt to convince all that will listen that price stability is its primary objective.”

Hear from Ray Dalio at the Best New Ideas in Money Festival on Sept. 21 and Sept. 22 in New York. The hedge-fund pioneer has strong views on where the economy is headed.

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