TREASURIES-U.S. 2-year yield at 19-month high, curve flattens

·2 min read

U.S. short-term Treasury yields rose further on Wednesday, causing the yield curve to flatten, as the possible timing of the Fed's first interest rate rise came into tighter focus.

In the run-up to the Federal Reserve's policy meeting next week, market focus has moved beyond just pricing in the central bank's likely taper of asset purchases and onto the timing of the first rate rise since December 2018.

Rising oil prices and inflation expectations have fed into that pricing. The Fed has signaled it will possibly begin next month to taper its $120 billion in monthly purchases of Treasury bonds and mortgage-backed securities, but Chair Jerome Powell said last week it wasn't yet time to raise rates.

Two-year yields spiked briefly above 0.5%, a level last seen in March 2020. Ten-year yields were around 1.6256%, just off one-week lows hit on Tuesday.

The spread between U.S. 5-year notes and 30-year bonds narrowed further to 84.6 basis points.

"This "taper-to-hike" transition was ostensibly reinforced by elevated oil, which is twisting the arm on policy amid surging inflation expectations," analysts at Mizuho said in a note.

Data in a survey from the Conference Board on Tuesday showed U.S. consumers' inflation expectations over the next 12 months jumped to 7.0%, the highest in 13 years, from 6.5% last month. Yet, despite perceptions of high inflation, consumers planned to step up spending.

An auction of two-year notes on Tuesday was strong, and yet that did little to dampen yields.

The U.S. 5-year inflation breakeven rate, which reflects inflation expectations over the next five years, hit another milestone on Tuesday, rising to 2.985%, the highest since at least January 2004.

Fed funds futures were pricing in a 70% chance of a June rate hike on Tuesday, even though the Fed's taper of asset purchases, if it begins in November, could end in June as well. (Reporting by Tom Westbrook and Vidya Ranganathan; Editing by Simon Cameron-Moore)

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