Bond yields inched lower on Tuesday as signs of cooling inflation in Europe counteracted more hawkish rhetoric from the Federal Reserve.
The yield on the 2-year Treasury
slipped by 1 basis point to 4.432%. Yields move in the opposite direction to prices.
The yield on the 10-year Treasury
retreated 2.8 basis points to 3.657%.
The yield on the 30-year Treasury
fell 1.5 basis points to 3.711%.
What’s driving markets
Benchmark U.S. government bond yields were a touch softer even as investors continued to absorb the latest hawkish comments from Federal Reserve officials.
St Louis Fed President James Bullard exemplified his colleagues’ stance when he said on Monday that the central bank will likely need to keep interest rates above 5% for most of next year in order to cool inflation that is currently running not that far below 40-year highs.
Markets are pricing in a 72% probability that the Fed will raise interest rates by another 50 basis points to a range of 4.25% to 4.50% after its meeting on December 14th, according to the CME FedWatch tool. The central bank is expected to take its Fed funds rate target to 5.0% by June 2023, according to 30-day Fed Funds futures.
U.S. economic updates set for release on Tuesday include the S&P Case-Shiller U.S. home price index and the FHFA home price index, both covering September and both due at 9 a.m. Eastern. The consumer confidence index for November will be published at 10 a.m..
Helping suppress yields is better news on inflation from Europe. The German 10-year bund yield
fell 8.6 basis points to 1.909% after data showed inflation in North Rhine-Westphalia, Germany’s industrial heartland, fell in November from October by 0.8%, against expectations for a rise of 1.2%. Year-on-year, the rate was 10.4%, against forecasts for 11%.
What are analysts saying
“Bullard… said markets are under-pricing the risk that FOMC might be more aggressive and again referred to the output of his Taylor Rule model, saying that he thinks the Fed should get to the bottom of the 5-7% range. That is an extremely wide spread and markets are already pricing a terminal rate that reaches the bottom of that range,” wrote Jan Nevruzi, U.S. rates strategist at Nat West.
“We expect the Fed to remain on hold in 2023, but reduce rates sharply in 2024, ending the year near 2%, which is well below market pricing. From today’s vantage point, it is hard to imagine how the Fed could even entertain cuts, but if rates are at 5% (terminal) when inflation is in the 7-8% range, I don’t think it would be a problem for the Fed to cut towards neutral if inflation gets back to our forecast of ~2% in 2024 (or shows a strong trend in that direction),” Nevruzi added.