Inflation Fears Send U.S. Bond Yields Surging Ahead of Fed Meeting

U.S. government-bond yields closed at their highest levels in more than a decade on Monday, propelled by fears that persistent inflation could push the Federal Reserve to raise interest rates even higher and faster than already expected.

 The yield on the benchmark 10-year Treasury note settled at 3.371%, according to Tradeweb, its highest close since April 2011 and up from 3.156% on Friday. The yield on the two-year Treasury—which often rises with expectations for Fed rate increases—rose to 3.279%, a new 15-year high, from 3.047% on Friday.

The surge extended in after-hours bond trading, which carried the 10-year yield briefly above 3.4%, following a Wall Street Journal report that Fed officials were likely to consider raising interest rates by a larger-than-expected 0.75 percentage point this week to fight inflation. Data Friday showed that consumer prices rose at an 8.6% annual rate in May, putting inflation at its fastest pace since the 1980s, despite measures the Fed has already taken to cool off the economy.

Traders quickly raised their expectations for the size of the Fed’s next interest-rate move. Late Monday, Fed funds futures, used by traders to bet on central-bank policy, showed a roughly 28% chance that officials would raise rates by 0.75 percentage point this week, up from about 3% a week ago.

The inflation reading has also boosted expectations of how high the Fed’s benchmark rate would eventually rise. Investors are now expecting the officials to raise rates to nearly 4% by next spring, up from last month’s expected peak around 3%. 

Fed officials have signaled that raising interest rates to bring down inflation is their top priority. The central bank’s 0.5-percentage-point rate rise at its May meeting—following a smaller increase in March—was already the most aggressive upward rate move the Fed had made in more than 20 years. 

On the other hand, raising rates even more quickly would defy the central bank’s previous guidance, and some analysts said it would make it harder for the Fed to monitor the effects of tighter monetary policy, which is critical to helping officials avoid tipping the economy into a recession. 

Moving too fast would be “like looking in your rearview mirror and realizing you missed your exit,” said

Gennadiy Goldberg,

senior U.S. rate strategist at TD Securities.

Treasury yields had already soared this year as rising inflation rapidly altered traders’ expectations for Fed policy. The 10-year yield’s climb has dented U.S. stock valuations, sending major indexes plummeting. Higher yields on ultrasafe bonds diminish the appeal of Wall Street’s riskier bets.

On Monday, the S&P 500 fell 3.9%, a decline that sent the index into bear-market territory, defined as a 20% fall from a recent high. The tech-heavy Nasdaq Composite dropped 4.7%.

In another sign of bond traders’ worries, a sale of new short-term Treasury debt finished with some of the weakest such results in years. Monday’s auction of new three-month bills ended with a yield 0.09 percentage point higher than traders had expected, the biggest such difference since September 2008, when markets were rattled by the global financial crisis, according to analysts at Jefferies.

Climbing Treasury yields lift costs for borrowers across the economy, from companies to home buyers. Yields on corporate bonds have surged this year even more than Treasury yields as investors demand higher premiums for lending money to businesses. Residential mortgage rates have jumped too, last month reaching their highest level since 2009. Local governments are issuing fewer new bonds, investors are turning pickier about buying specialized debt securities and the blistering real-estate market is showing signs of slowing.

Although worries are mounting for how rising rates will hit economic growth, high inflation may force the Fed’s hand, some analysts said.

“Fed officials who very recently were expressing hopefulness that inflation would slow over the course of the year will now have to confront a backdrop of prices that are accelerating despite the rapid tightening of financial conditions,” Citigroup economists wrote.

Write to Matt Grossman at matt.grossman@wsj.com

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Appeared in the June 14, 2022, print edition as ‘Bond Yields Reach 11-Year High.’

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