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Bond Report: Aggressive Treasury selloff lifts 10-year rate above 2% and flattens the curve after inflation comes in hotter than expected

Treasury yields moved substantially higher Thursday afternoon — led by the 2-year rate, which was headed for its biggest one-day gain in more than a decade — after the U.S. inflation rate for January came in at a 40-year high of 7.5%.

After the data, traders began aggressively pricing in the chance of a 50 basis point interest rate hike by the Fed in March, the 10-year yield rose above 2%, and fresh parts of the Treasury curve temporarily inverted. Meanwhile, the spread between 2- and 10-year rates flattened to levels not seen since 2020.

What are yields doing?

The yield on the 10-year Treasury note
TMUBMUSD10Y,
2.017%

rose 11 basis points to 2.039%, compared with 1.928% at 3 p.m. Eastern on Wednesday, hitting a level last seen in 2019.

The 2-year Treasury yield
TMUBMUSD02Y,
1.541%

climbed around 20 basis points to 1.538% versus 1.346% on Wednesday afternoon. That would put it on pace for its biggest daily gain since June 2009, based on preliminary analysis by Dow Jones Market Data.

The spread between the 2- and 10-year rates flattened to 47 basis points, the narrowest since 2020.

The yield on the 30-year Treasury bond
TMUBMUSD30Y,
2.298%

stood at 2.329%, up roughly 10 basis points from 2.232% late Wednesday.

What’s driving the market?

The rate of U.S. inflation climbed to 7.5% last month and stayed at a 40-year high, suggesting the upward pressure on consumer prices is unlikely to relent much soon. The 7.5% surge in the cost of living in the past 12 months is the biggest since February 1982, and exceeded the 7.2% estimate of economists surveyed by The Wall Street Journal.

Read:U.S. inflation rate climbs to 7.5% after another sharp increase in consumer prices

A separate measure of consumer inflation that strips out volatile food and energy prices also rose 0.6% last month, the government said Thursday. Meanwhile, the increase in the so-called core rate over the past 12 months moved to 6% from 5.5%. That’s the highest level since August 1982. 

Fed-funds futures traders responded by raising the likelihood of a half percentage point increase in the benchmark interest rate by the Federal Reserve in March to as high as 83%, according to the CME FedWatch Tool.

See: ‘Blowout’ U.S. inflation leads traders to raise bets for a half-point Fed rate hike in March to as high as 83%

Meanwhile, Thursday’s government-bond selloff picked up momentum just as Bloomberg News reported Federal Reserve Bank of St. Louis President James Bullard as saying he supports lifting rates by a full percentage point by the start of July. “I’d like to see 100 basis points in the bag by July 1,” he said.

Mark Hulbert: The surprising twist in what rising inflation means for the stock market

What do analysts say?

“Today’s blockbuster inflation readings follow Friday’s blockbuster employment report, in what has become an extraordinary string of data as the economy once again works through and out of pandemic-driven conditions,” said Rick Rieder, BlackRock’s chief investment officer of global fixed income, in a note.

“Now that the central bank has found itself behind the curve, we think policy needs to adjust quickly, but not necessarily too much in total amount as the Fed weighs data over time, since this would create significant risk for markets and the economy,” he wrote. “So, while the time has come (or did months ago) to move policy persistently and aggressively away from overly accommodative conditions, and toward a more neutral and appropriate stance, executing on this pivot is going to be a real challenge for policy makers.”

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