Treasury Yields Surge, then Moderate

Expectations for where the Federal Reserve will need to take its benchmark rate in 2023 rebounded and Treasury yields initially surged after U.S. employment and wage gains exceeded forecasts during November.

The Treasury selloff pushed two-year yields up by as much as 18 basis points (bps), to 4.41 percent, while the 10-year yield added 13 bps, to 3.63 percent. After that initial surge, the selloff found buyers later in the session, and benchmarks cut their losses by more than half, with the 30-year yield turning lower in early afternoon trading.

The steadier tone extended to market expectations for where the central bank’s target will top out next year. Overnight-index swaps linked to Fed meetings showed a peak rate of 4.98 percent, before a modest pullback that left the contract still up 10 bps from where it was before the jobs data.

The upside surprise from the jobs report jolted a Treasury market that had rallied sharply over the past two days, a move sparked by Fed Chair Jerome Powell indicating the central bank could shift to smaller rate increases as soon as this month to avoid over-tightening. Ahead of the jobs data, the two-year yield was trading below 4.20 percent, its lowest level since early October and down from a high of 4.54 percent on Wednesday, before Powell spoke.

“The market was mispriced,” said Gregory Faranello, head of U.S. rates trading and strategy for AmeriVet Securities. “Two-year yields probably belong near 4.75 percent, with the Fed set to raise rates by another 50 basis points this month.” The reaction to Powell’s comments “took the anticipated downsizing in rate hikes too far,” he said.

The selloff left intact market expectations that the Fed will revert to a half-point rate increase this month, following its four three-quarter point hikes. The pace of hikes has faded in importance, however, relative to the ultimate destination and how long to remain there while waiting for inflation to moderate.

“This employment report fails to provide the picture the Federal Reserve would prefer to feel that they are making progress in slowing the economy,” Jason Pride, chief investment officer of Private Wealth at Glenmede, wrote in a note.

U.S. employers added more jobs in November than expected, and wage growth picked up from the prior month, indicative of labor demand that’s still too strong for the Federal Reserve in its quest to stomp out inflation.

Non-farm payrolls increased 263,000 last month after an upwardly revised 284,000 gain in October, a Labor Department report showed Friday. The unemployment rate held at 3.7 percent, as participation eased. Average hourly earnings rose twice as much as forecast after an upward revision to the prior month.

“The Fed is going to keep at it until the labor market cracks,” University of Chicago professor and former central bank governor Randall Kroszner said on Bloomberg TV. “And the labor market has not cracked.”

While the bond market clearly reacted positively to Powell’s desire not to tighten too far and crash the economy, it “was not paying attention to his comments on labor market demand that is producing higher wages,” said Kevin Flanagan, head of fixed income strategy at Wisdom Tree Investments. “Another 100 basis points of Fed hikes from here means Treasury yields are going higher, especially the front end.”

—With assistance from Liz Capo McCormick & Cristin Flanagan.

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