Treasury Yields Leap as US Services Data Add Fuel to Fed Bets

(Bloomberg) — Treasuries sold off as stronger-than-expected US economic data added fuel to traders’ bets on how high Federal Reserve interest rates might ultimately go.

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The pullback in US debt markets drove yields in the belly of the curve up by around 10 basis points, with the 10-year rate jumping to 3.58%. Swaps showed a similar increase in expectations for where the Fed terminal rate will be, with the market indicating a peak of close to 5% in the middle of 2023. The dollar also jumped, while US stocks lost ground.

The Treasury market was already under pressure Monday ahead of key data on services and factory orders that showed a healthier economic picture, and the move extended on the back of those figures. Yields nevertheless remained within their range from Friday, when a robust jobs report prompted a surge in yields that then largely faded out by the end of the day.

Monday’s moves got a major fillip from a fresh reading of the Institute for Supply Management’s services gauge, which unexpectedly rose to 56.5 in November from 54.4 the month before. The increase in the business activity measure was the biggest since March 2021, suggesting the largest part of the US economy remains resilient.

“That’s a hard number to argue with,” said Tony Farren, managing director in rates sales and trading at Mischler Financial Group. “The long end of the Treasury market has been saying the economy’s going to roll over. This takes away one of the pieces of ammo for the long end to say: despite employment, the economy’s weak.”

Markets could continue to be choppy as the end of the year approaches and along with it the final Fed meeting of 2022 on Dec. 13-14. Markets continue to price a half-point increase for that gathering, little changed from before the most recent data, which would represent a slowing in the pace of tightening. The Fed boosted rates by 75 basis points at its last meeting.

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Officials from the central bank are in the traditional pre-meeting blackout period and unable to give further guidance, so investors are likely to be even more keenly focused on data releases, including next week’s consumer-price inflation report.

On top of that, liquidity — already under strain — is typically less ample heading into the final holiday-affected stretch of the year, meaning there is scope for smaller transactions to spur large moves.

Thinning year-end liquidity is playing a big role in exacerbating swings and “each data release has an outsized influence” in such an environment, said Lindsay Rosner, a portfolio manager at PGIM. “The jobs number was strong and that makes people nervous. Year end is an impactful time of tax loss harvesting and positioning for next year. Everyone is trying to figure out the trend for the economy and Fed policy and this will continue into next year.”

–With assistance from Michael MacKenzie.

(Updates to add investor comment.)

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