U.S. Treasury yields showed mixed moves on Monday as markets digested a robust jobs report released last week that pushed interest-rate expectations higher. Short-term yields retreated modestly from recent peaks while longer-dated yields ticked up, reflecting a recalibration of Fed policy odds by investors.
The two-year Treasury yield - which typically tracks expectations for Federal Reserve policy moves - fell 1.7 basis points to 4.145%, pulling back from a 15-month high reached on Friday. By contrast, the benchmark 10-year note yield rose 0.6 basis points to 4.54%, a divergence that steepened the 2-10 year yield curve to about 40 basis points.
Last week’s stronger-than-expected jobs figures altered a market narrative that had treated a softening labour market as a restraint on Fed tightening, even as inflation remained above the central bank’s 2% target. Fed funds futures traders currently see a 68% probability of an interest-rate increase by December, a shift driven by the employment data.
Energy prices have added another layer to the outlook. Elevated oil prices, which market participants link to supply disruptions stemming from the Iran war, have fuelled worries that headline inflation could gain traction and spill into broader consumer prices.
"We do have this obvious push from energy inflation that’s increasing the headline numbers and pushing us further away from target. But I think on the other side of this, there is a pretty steep decline in energy prices that’s eventually going to come," said Thomas Simons, chief U.S. economist at Jefferies.
Simons expects consumer price inflation to fall back below 2% within a year as this year’s inflation spikes make next year’s figures look lower by comparison. Still, many analysts say the Fed is unlikely to initiate further rate hikes unless inflation expectations rise more broadly and inflation becomes embedded in core consumer prices.
Market attention will also focus on the consumer price inflation release scheduled for Wednesday. Consensus expectations in market commentary show core consumer prices easing on a monthly basis in May to 0.3% from 0.4% in April, while the annual core reading is expected to accelerate slightly to 2.9% from 2.8%.
Supply-side events in the Treasury market are notable this week as the U.S. Treasury will auction $119 billion of new coupon-bearing debt. The calendar includes $58 billion in three-year notes on Tuesday, $39 billion in 10-year notes on Wednesday and $22 billion in 30-year bonds on Thursday, which could influence yields depending on investor demand.
Key points
- Short-term yields fell while longer-term yields rose: 2-year down to 4.145%, 10-year up to 4.54% - steepening the 2-10 curve to 40 basis points.
- Stronger jobs data has increased the perceived likelihood of a Fed rate increase later this year - fed funds futures put the chance of a hike by December at 68%.
- Elevated oil prices due to supply disruptions tied to the Iran war are raising concerns that headline inflation may remain elevated and affect core consumer prices; CPI data on Wednesday will be closely watched.
Risks and uncertainties
- Persistently higher energy prices could keep headline inflation elevated and complicate the Fed’s path - this primarily affects consumer-facing sectors and inflation-sensitive assets.
- If inflation expectations rise and core inflation becomes entrenched, markets could price in additional rate hikes, which would influence short-term interest rates and financial conditions.
- Large Treasury supply this week - $119 billion across three-, 10- and 30-year notes - could add volatility to yield moves depending on auction demand and investor positioning.
Investors and policymakers will be watching incoming inflation data and Treasury auctions for signals on the durability of price pressures and the likely course of monetary policy.