Investor Alert

Bond Report

Jan. 18, 2022, 4:02 p.m. EST

Treasury yields surge to 2-year high, traders see risk of 50-basis-point Fed hike in March

By Vivien Lou Chen and William Watts

Yields on two- and 10-year Treasurys surged to their highest levels in roughly two years on Tuesday as investors returned from a three-day U.S. holiday, factoring in the risk that the Federal Reserve may deliver a half-point interest rate hike in March.

The yield on the 2-year Treasury note, which is more sensitive to Fed rate expectations, held above the 1% threshold for the first time since February 2020. The 10-year yield climbed above 1.8% to reach its highest since January 2020.

What are yields doing?

  • The yield on the 10-year Treasury note (XTUP:BX:TMUBMUSD10Y) rose 9.5 basis points to 1.866%, up from 1.771% at 3 p.m. Eastern on Friday. That’s the highest since Jan. 8, 2020, based on 3 p.m. levels, according to Dow Jones Market Data.

  • The 2-year Treasury yield (XTUP:BX:TMUBMUSD02Y) advanced 7.3 basis points to 1.038%, versus 0.965% on Friday afternoon. It’s the highest since Feb. 27, 2020, and the largest one-day gain since last November.

  • The yield on the 30-year Treasury bond (XTUP:BX:TMUBMUSD30Y) climbed 7.1 basis points to 2.185%, up from 2.114% late Friday. That’s the highest yield since June 16 of last year.

What’s driving the market?

Treasury yields have risen significantly in the new year, with traders pricing in some risk that the Federal Reserve may deliver a one-shot 50-basis-point rate hike in March to combat persistently high inflation. Such a rate hike would be the first of that size since May 2000. Read: Investors brace for risk of first half-point Federal Reserve rate hike in more than 20 years in March

As of 3 p.m. Eastern time Tuesday, the 10-year Treasury yield was up 33.9  basis points over the first 11 trading days in 2022. Meanwhile, the 2-year yield, or rate most closely associated with the path of Fed policy, was up 30 basis points. With yields rising when bonds sell off, that gives the 2- and 10-year maturities their worst start to a year since 1982, when the 10-year rate hovered above 14%, according to Dow Jones Market Data. Beyond the size of the first rate hike, some corners of the market are also considering the prospect for a faster-than-expected wind down of bond purchases by the Fed than the current March timeframe, one that might end in February or completely stop in January, though an abrupt halt at the Fed’s Jan. 25-26 meeting is deemed as unlikely to happen. Lastly, some analysts see Tuesday’s jump in yields as partly a reflection of a market that may be beginning to raise its expectations for how high the Fed will ultimately raise its policy interest rate. That’s the case even though fed funds futures, as of early Tuesday, implied the Fed’s policy rate target won’t get any higher than 1.5% out to 2023, from its current level between zero and 0.25%.

On the U.S. economic calendar, the New York Fed’s Empire State Manufacturing Index turned negative for the first time in a year and a half, and nosedived to -0.7 points in January from 31.9 in the prior month. The National Association of Home Builders index fell 1 point to 83 in January.

What are analysts saying?

  • “It’s all about the Fed,” Scott Buchta of Brean Capital wrote in a note. “The market is quickly beginning to reposition itself for higher inflation rates and a more aggressive Fed,” with the probability of a March hike now seen at 100%. Meanwhile, “expectations are growing for a faster wind down of QE purchases (i.e. wind down in Feb, or stop completely in January).”

  • “The market has turned more aggressive about the outlook for Fed policy. At the end of last year, the market had less than a 2-in-3 chance of a March hike. Now it has a hike fully discounted and about a 1-in-3 chance of a 50 bp (basis point) move,” said Marc Chandler, chief market analyst at Bannockburn Global Forex, in a note. “At the end of last year, the market had almost three hikes fully discounted for this year. Now the market has about 107 bp completed priced in.”

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