Yields rise with Fed policy in focus

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NEW YORK — U.S. Treasury yields rose on Monday as investors evaluated how high the Federal Reserve will ultimately hike interest rates and how long it will hold them at higher levels as it battles persistently high inflation.

A sell-off in European government bonds also weighed on the U.S. market.

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The U.S. central bank will deliver more interest rate hikes next year even as the economy slips toward a possible recession, Fed Chair Jerome Powell said on Wednesday, arguing that a higher cost would be paid if the U.S. central bank does not get a firmer grip on inflation.

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Fed presidents on Friday, including New York’s John Williams, San Francisco’s Mary Daly, and Cleveland’s Loretta Mester, reiterated this message, saying that the U.S. central bank may need to lift U.S. borrowing costs above the peak 5.1% they penciled in at the Fed’s December meeting and keep them there, perhaps into 2024.

Bond investors, however, are pricing in less aggressive rate increases than Fed officials are signaling.

“Part of that could be that the market’s expecting an imminent recession,” said Gennadiy Goldberg, an interest rate strategist at TD Securities in New York, though he added that “I don’t think (it) is likely. The consumer is still quite strong and labor markets are just too tight.”

Personal consumption expenditures (PCE) data for November due on Friday will be the next major focus for further clues about price pressures.

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Investors are optimistic that inflation will subside and that the Fed will respond to data with less hawkish policy, which has created a divergence in expectations between the market and Fed officials, according to analysts at Barclays Capital.

Fed funds futures traders are pricing for a peak rate of around 4.88% in May, and then a decline to 4.40% by year-end.

Benchmark 10-year note yields were last at 3.581%. They are above an almost three-month low of 3.402% on Dec. 7, but are holding well below the 15-year high of 4.338% reached on Oct. 21.

Two-year yields were at 4.254%, and are below a 15-year high of 4.883% hit on Nov. 4.

The yield curve between two-year and 10-year notes remains deeply inverted at minus 68 basis points, indicating concerns about a recession in the next one to two years.

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Yields were also pulled higher on Monday in line with rising euro zone borrowing costs as investors worried about a hawkish European Central Bank and increasing bond supply.

German business morale rose more than expected in December as the outlook for Europe’s largest economy improved despite an energy crisis and high inflation, a survey showed on Monday.

Moves this week are expected to be choppy with many investors out, or reluctant to take risks, before the Christmas and New Year holidays.

The Treasury Department will sell $12 billion in 20-year Treasuries on Wednesday and $19 billion in five-year Treasury Inflation-Protected Securities (TIPS) on Thursday. (Reporting by Karen Brettell; Editing by Andrea Ricci and Jonathan Oatis)