Treasury Two-Year Yield Surges as CPI Shock Spurs Fed Repricing

(Bloomberg) — Yields on benchmark Treasury two-year notes surged again Monday as Friday’s US inflation surprise spurred investors to price in more aggressive Federal Reserve rate hikes.

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The yield climbed as much as 9 basis points to 3.15%, the highest since 2007 after data showed on Friday that US May consumer prices exceeded even the highest economist estimate in a Bloomberg survey.

Investors are awaiting the central bank’s updated projections on the US economy, inflation and the federal funds rate when it releases its policy decision on Wednesday. Traders see 50-50 odds of the Fed raising rates by three-quarters of a percentage point in July, while Barclays Plc became the first major bank to predict this move could come as early as next week.

“Fed Chair Powell may suggest that policy makers won’t rule out a rate hike of more than 50 basis points,” Naokazu Koshimizu, a senior rates strategist at Nomura Securities in Tokyo, wrote in a note on this week’s meeting. “But the upward bias for Treasury yields is at extreme levels, so once the market prices in the probability of a 75-basis-point hike, there’ll be short-covering.”

The deepening sell-off in Treasuries reverberated through Asian markets, with Japan’s 10-year yield at the 0.25% ceiling that the nation’s central bank tolerates. Similar-tenor yields in New Zealand climbed above 4% for the first time since 2014.

Meanwhile, hedge funds timed their bond bets to perfection, turning bears on every single Treasury futures contract tracked by Bloomberg, right before the shock inflation print sent debt markets tumbling. Leveraged fund net positions flipped negative on two-year Treasury futures last week, having done the same for benchmark contracts the week before, according to the latest Commodity Futures Trading Commission data.

Hedge Fund Bond Bears Timed US Inflation Shock to Perfection

The dollar followed yields higher, rising against every peer on Monday as investors rushed to buy the haven asset.

(Updates throughout)