Bonds are falling as rising inflation fuels bets for a 100 basis point Fed rate hike

(Bloomberg) – US Treasury yields jumped after a hotter-than-expected inflation report raised bets that the Federal Reserve could raise interest rates by up to a full percentage point this month.

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The increase was driven by short-term securities sensitive to policy changes, with two-year bond yields rising as much as 16 basis points to 3.21% before paring the jump. This pushed the yield above 10-year bond yields by the most since 2006, indicating increased risks that higher rates will halt economic growth.

The 9.1% annual rise in CPI was the largest since 1981 and the latest in a series of faster-than-expected increases that are prompting the Federal Reserve to act more aggressively to prevent inflation from becoming entrenched.

After the report, traders priced in a hypothetical certainty that the Fed would increase its benchmark rate by three-quarters of a percentage point at its July and September meetings, with a third chance of a full point increase at this month’s meeting. On Wednesday, the Bank of Canada surprised the markets by raising interest rates by this amount.

“Major data is going to be very problematic for the Fed’s messaging and is going to stay for a long time,” said David Rubin, strategist at TJM. “A 75 basis point rise is certain in July and now 75 basis points is again more certain in September as the Fed is pulling back more and more behind the curve.”

Persistent inflation comes after the Federal Reserve raised its policy rate by 75 basis points in June, the largest increase since 1994, and monetary tightening cooled interest rate-sensitive sectors of the economy such as home sales. Another three-quarter point increase in July was already priced in swaps ahead of the CPI data. After that, contracts price the chances of a bigger move.

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Treasuries pared their losses in mid-morning trading as share prices fell shortly after the opening bell. Two-year bond yields rose by about 13 basis points, while 10-year bond yields rose by 5 basis points at 3.02%.

While the cost of hotel and airline rates, as well as car rentals, declined from May to June, after historical increases in recent months, price pressures accelerated in other sectors, such as housing.

Those details suggest the inflation report isn’t as strong as it seems, because declines in things like travel expenses suggest consumers are holding back, said Gang Ho, managing partner at Winshore Capital Partners, which specializes in inflation protection. investments.

Hu said stronger components such as housing are likely to decline in the coming months due to higher interest rates.

“What it does is it may push people’s expectations of inflation higher, and force the Fed to overshoot,” Hu said. It is not an appropriate number for the market, he said.

The swaps market shows that the Fed’s benchmark borrowing costs may peak at around 3.75% in the first quarter, from the current level of 1.75%. Traders then expect the Fed to start cutting interest rates.

Investors will be watching closely in the coming days for signals from Federal Reserve officials on whether they will increase the range of interest rate hikes at the July 27 meeting.

Priya Misra, global head of price strategy at TD Securities, said she expects the Fed to commit to a three-quarter point hike, given President Jerome Powell’s previous guidance.

“The Fed is very smart and unconditionally focused on inflation. But we think they will get to 75,” she said on Bloomberg TV. “We’ll see if their message changes.”

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