Bond Report: Treasury yields fall across the board, posting biggest one-day drop in more than a week

Treasury yields dropped across the board Wednesday, with the 2-, 10-, and 30-year maturities falling by the most in more than a week, as investors focused on the risk that tighter Fed policy will hurt the U.S. recovery.

Meanwhile, a $23 billion 20-year bond auction produced what Jefferies LLC economists described as “weak” results.

What are yields doing?

The yield on the 10-year Treasury note

fell 2.8 basis points to 1.604%, compared with 1.632% at 3 p.m. Eastern on Tuesday.

The 2-year note

yield declined 1.8 basis points to 0.502%, from 0.52% Tuesday afternoon.

The 30-year Treasury bond yield

dropped 2 basis points to 1.997% versus 2.017% late Tuesday.

It was the biggest one-day drop for all three yields since Nov. 9, based on 3 p.m. levels, according to Dow Jones Market Data. The 10- and 30-year yields broke winning streaks that lasted four trading days.

What’s driving the market?

Yields dropped on Wednesday as investors focused on the potential impact of the Fed’s future policy path. Ten- and 30-year yields fell despite the elevated inflation environment because of “the risk that Fed normalization will derail the recovery,” according to BMO Capital Market’s Margaret Kerins.

New York Fed President John Williams, appearing at a virtual conference on the Treasury market, said his bank’s actions to stabilize the Treasury market at the start of the pandemic is a reminder that markets need to be bolstered to prepare for the next big shock.

Meanwhile, Fed Gov. Christopher Waller, also appearing in a virtual conference, said stablecoins could be a healthy form of payment system competition, although they require regulating.

Still on deck for Wednesday are Atlanta Fed President Raphael Bostic, who is slated to deliver remarks at a Fed event on housing for vulnerable renters at 4 p.m., and Chicago Fed President Charles Evans, who is participating in a Q&A session at the Mid-Size Bank Coalition of America event at 4:05 p.m. Eastern.

Data released on Wednesday showed that October new home construction ebbed, while permitting activity continued at a steady clip, pointing to the challenges builders are facing in starting and completing projects.

U.S. home builders started construction on homes at a seasonally-adjusted annual rate of 1.52 million last month, representing a 0.7% decrease from the previous month, the U.S. Census Bureau reported. Compared with October 2020, housing starts were up 0.4%.

Permitting for new homes occurred at a seasonally-adjusted annual rate of 1.65 million, up 4% from September and 3.4% from a year ago. Economists polled by MarketWatch had expected housing starts to occur at a median pace of 1.63 million and building permits to come in at a median pace of 1.58 million.

Since September, a sharp rise in Treasury yields at the short end of the yield curve has been driven by growing expectations the Federal Reserve will move more quickly than previously anticipated to tighten policy and rein in inflation. Longer-dated yields have been volatile but within a range over the past month.

Some investors see the resulting flattening of the curve as warning that the Fed may move so aggressively that it causes an economic downturn, while others contend that market participants are underestimating how long-lasting inflation could prove to be.

See: This Treasury dealer says the market has it entirely wrong on the Fed and interest rates.

What are analysts saying?

“There’s such a wide dispersion of views at the Fed that it’s really tough to make a call on the pace and magnitude of the Fed’s reaction to high inflation,” said Kathy Jones, chief fixed income strategist for Charles Schwab.

Still, further flattening of the yield curve is likely because “it’s typically what happens in tightening cycles, when the Fed starts to withdraw liquidity and raise interest rates,” she said via phone. “The flattening is likely to be driven by shorter-end rates rising faster than those in the longer end. We could see yields shift up across the curve, which will slow things down in the economy and tighten financial conditions.”

In a 2022 fixed-income outlook released Wednesday, Jones said Schwab’s estimate for the high end of the 10-year Treasury yield “is in the 1.75% to 2.0% range.”

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