(Bloomberg) -- U.S. Treasuries gained, bouncing back from an initial wave of selling after consumer-price inflation accelerated at the fastest annual pace in four decades in December, with traders already widely anticipating that the Federal Reserve will start raising interest rates in March.
The inflation figures were in line with the bond market’s expectations, and while benchmark Treasury yields initially rose moderately across the curve soon after the release, buyers soon emerged. The year-on-year jump in the consumer price index matched a forecast 7%, while the core rate, which excluded food and energy prices, was a little hotter, expanding at a pace of 5.5%, versus an expected 5.4%.
The policy sensitive two-year note yield was up one basis point to 0.89% after earlier rising as much as 3 basis points, while the benchmark 10-year note yield was down 1.6 basis points at 1.72% in the wake of a brief jump above 1.75%. Interest rate futures continued to reflect an 88% probability of a quarter-point rate hike in March.
Amid a volatile start to the year, another test of investor sentiment beckons with the sale of $36 billion 10-year notes on Wednesday. The reopening is set to arrive at the highest yield since January 2020 and that may entice buyers after a sharp rise in the benchmark’s yield from 1.51% at the end of last year.
“It is extremely counter-intuitive to see the market rally after such a hot inflation number,” said Gregory Faranello, head of U.S. Rates at AmeriVet Securities. “The market has aggressively repriced expectations for tighter Fed policy since the start of the year and it’s not a surprise to see some consolidation. The auctions should be well supported at these levels for 10-, and 30-year yields.”
As the U.S. economy endures a period of elevated inflation pressure and wage gains are growing at a robust pace, there is concern that the central bank’s monetary conditions remain very loose. Fed chair Jerome Powell said the central bank will use its tools “to prevent higher inflation from becoming entrenched,” at his confirmation hearing before the Senate Banking Committee on Tuesday. “If we see inflation persisting at high levels longer than expected [and] we have to raise interest rates more over time, we will,” Powell told lawmakers. Other Fed officials have recently lent weight to the idea of raising rates in March, while advocating shrinking the central bank’s $8.8 trillion balance sheet later this year.
The bond market has looked past high inflation reports in recent months, with many expecting a moderation over the coming year as long-term disinflationary trends of technology, greater automation and aging populations offset the current pandemic-related pressure. Treasury breakeven rates over the next five-, and 10-years peaked last November and were close to unchanged after the latest figures were released on Wednesday at 2.92% and 2.58% respectively.
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