TREASURIES-U.S. 2-year yield at 19-month high, curve flattens

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LONDON, Oct 27 (Reuters) – U.S. two-year Treasury yields rose further on Wednesday, hitting new 19-month highs and flattening the yield curve, as the possible timing of the Fed’s first interest rate rise came into tighter focus.

In the run-up to the Federal Reserve’s policy meeting next week, market focus has moved beyond pricing in the central bank’s likely taper of asset purchases and onto the timing of the first rate rise since December 2018.

Rising oil prices and inflation expectations have fed into that pricing, even though but Fed Chair Jerome Powell said last week it wasn’t yet time to raise rates.

The Fed is widely expected to begin tapering its $120 billion in monthly purchases of Treasury bonds and mortgage-backed securities from next month, but Fed funds futures already priced a 70% chance of a June rate hike on Tuesday.

“This ‘taper-to-hike’ transition was ostensibly reinforced by elevated oil, which is twisting the arm on policy amid surging inflation expectations,” analysts at Mizuho wrote.

Two-year yields spiked briefly above 0.5%, a level last seen in March 2020 while the five-year yield — another segment of the curve that’s particularly sensitive to interest rate expectations — also rose as much as 2 bps but held below 19-month highs.

Shorter-dated yields were not dampened even after an auction of two-year notes on Tuesday garnered strong demand.

Ten-year yields on the other hand slipped to a one-week low 1.6070%, in turn narrowing the spread between the two- and 10-year yields to 109 bps, the flattest in over a month .

The spread between U.S. 5-year notes and 30-year bonds narrowed to as low as 82 bps.

Data in a survey from the Conference Board on Tuesday showed U.S. consumers’ inflation expectations over the next 12 months jumped to 7.0%, the highest in 13 years, from 6.5% last month.

Yet, despite perceptions of high inflation, consumers planned to step up spending.

The U.S. 5-year inflation breakeven rate, which reflects market-based inflation expectations over the next five years, hit another milestone on Tuesday, rising to 2.985%, the highest since at least January 2004.

Ten-year breakevens were at the highest since mid-2006 .

Some remain confident however the inflation surge will abate as the post-pandemic recovery normalises. Analysts at consultancy BCA said the recent increase in “inflation compensation” was excessive and advised clients to go short two-year inflation-linked Treasury bonds.

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