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Bond Report: 2-year Treasury yield drops by most since February after Powell says officials aren’t considering a jumbo-size rate hike

The 2-year Treasury yield, which is most closely tied to the Federal Reserve’s near-term policy path, fell by the most since February on Wednesday, after Federal Reserve Chairman Jerome Powell said officials aren’t actively considering a 75 basis point rate hike at the next meeting.

Policy makers also revealed they won’t begin shrinking their almost $9 trillion balance sheet until June. Stock investors cheered the developments, even though Powell said more 50 basis point hikes like Wednesday’s are on the table.

What yields are doing

The 2-year Treasury-note yield BX:TMUBMUSD02Y fell 15.4 basis points to 2.614% from 2.768% on Tuesday afternoon. Tuesday’s level was the highest since Dec. 12, 2018. Wednesday’s drop snapped five straight sessions of advances and was the biggest one-day decline since Feb. 28, based on 3 p.m. yields, according to Dow Jones Market Data.

The yield on the 10-year Treasury note
TMUBMUSD10Y,
2.920%

declined 4.3 basis points to 2.914% from 2.957% at 3 p.m. Eastern on Tuesday.

The 30-year Treasury bond yield
TMUBMUSD30Y,
3.003%

slipped less than 1 basis point to 3.001% from 3.006% late Tuesday. It’s still the yield’s third-highest level this year.

What’s driving the market

As expected, the Fed lifted the fed-funds rate by 50 basis points, or a half percentage point, to a range between 0.75% and 1%, while outlining its plan to begin shrinking its almost $9 trillion balance sheet on June 1. Policy makers also said ongoing rate hikes will be appropriate.

See: Fed lifts interest rates by 1/2 point and is set to wind down $9 trillion balance sheet in June

During a post-meeting press conference, Powell said the Fed has the tools and resolve to bring inflation down to its 2% target, and that additional 50 basis point hikes should be on the table over the next couple of meetings. He added that policy makers are not actively considering a larger 75 basis point move.

Wednesday’s rate hike comes as the Fed attempts to stamp out inflation that’s running at its highest since the early 1980s. The Fed typically moves its benchmark interest rates in quarter-point increments, and hadn’t previously hiked by a half-point since May 16, 2000.

As of late Wednesday, fed-funds futures traders still priced in a 79% chance of a 75 basis point Fed hike next month, down from 95% a day ago, according to the CME Fed Watch Tool. The odds of a 50 basis point hike in June went up to 20% versus 4.3% on Tuesday.

In U.S. data releases earlier Wednesday, private-sector payrolls rose by 247,000 in April, the slowest pace of job growth since the 2020 recession, according to the ADP National Employment Report. Economists surveyed by The Wall Street Journal had expected a gain of 390,000 jobs.

Meanwhile, the U.S. economy’s service side slowed in April due to high inflation and shortages: An ISM barometer of business conditions at service-oriented companies such as banks, retailers and hospitals fell 1.2 points to 57.1% last month, below the 58.3% forecast of economists.

The U.S. trade deficit jumped more than 20% to a record $109.8 billion in March.

What analysts say

“We expect another 50 basis point hike in June, but after that, we’re not so sure the Fed will continue at such a hot pace,” said Collin Martin, a fixed income strategist at Schwab Center for Financial Research. “We think inflation is close to peaking, and if there are signs that inflation is in fact cooling off in the second half of the year, the Fed may be able to take a breather and hike by 25 basis point increments instead.”

Referring to “quantitative tightening,” or the process of shrinking the Fed’s balance sheet, Chris Low, chief economist at FHN Financial, wrote: “A very slow start to QT” plus a surprising drop in Treasury issuance “means there is not going to be much if any T in QT this year, as the market is not going to have to absorb any additional supply.”

A 75 basis point hike on Wednesday would have theoretically been “the right move” to combat inflation, said head trader John Farawell at Roosevelt & Cross, a bond underwriter in New York. “There’s no doubt about it, this is a nervous market with rates likely to climb from here,” he said via phone. “Watch the front end of the curve: We may see the curve flattening again” in weeks to come as traders position for the prospect of a bigger hike in June.

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