Hawkish remarks from Fed officials prompt jump in Treasury yields

Several Federal Reserve officials on Tuesday signaled the US central bank was committed to its aggressive fight against soaring prices, prompting a jump in short-dated Treasury yields as investors priced in more interest rate rises.

The two-year yield, which moves with interest rate expectations, jumped by 0.2 percentage points to 3.08 per cent, its biggest daily move since mid-June. The three-year yield rose by 0.23 percentage points, also its largest move since mid-June, to breach 3 per cent.

San Francisco Fed president Mary Daly said in an interview on LinkedIn that the central bank was “nowhere near” done with its fight to cool inflation, which continues to run at 40-year highs.

Her remarks come after the Fed’s meeting last week at which chair Jay Powell suggested it might be appropriate to slow the pace of interest rate increases, prompting a relief rally in markets.

In a separate interview on Tuesday, Chicago Fed president Charles Evans said he thought that a 0.5 percentage point increase at the next meeting in September would be appropriate. However, he left the door open to a larger 0.75 percentage point rise, which he said “could also be OK”.

Subadra Rajappa, head of US rates strategy at Société Générale, said Daly’s comments had “triggered” the sell-off in the US Treasury market, where yields move inversely to prices. “It’s hard to know. . . if the market is just overreacting,” Rajappa added.

Tom Simons, a money market economist at Jefferies, said that Evans “tends to be very dovish, so this hawkish note is important”.

After the meeting of the Federal Open Market Committee, investors had started pricing in a series of smaller rate increases later this year amid signs the Fed’s aggressive monetary tightening has started to cool down the US economy.

But the comments from Daley and Evans moved futures markets, with expectations for where the Fed’s benchmark policy rate will stand in December rising from 3.27 per cent on Monday to 3.39 per cent on Tuesday.

The Fed comments come after the commerce department last week reported that the US economy shrank for a second consecutive quarter, meeting one of the common criteria for a recession. It contracted by 0.9 per cent on an annualized basis in the second quarter, following a 1.6 per cent contraction in the first three months of 2022.

Investors also cautioned that liquidity in the Treasury market — the ease with which traders can buy and sell — is poor, with many market participants on holiday this month. A deterioration in liquidity can lead to big swings in the price of securities.

Elsewhere, US stocks were mixed on Tuesday as Nancy Pelosi’s arrival in Taiwan stoked tensions between the US and China.

Wall Street’s S&P 500 share index was down 0.3 per cent after oscillating between small gains and losses throughout the day. The tech-heavy Nasdaq Composite inched up 0.2 per cent. Europe’s Stoxx 600 fell 0.3 per cent, while MSCI’s broad index of Asia-Pacific stocks dropped 1.3 per cent.

China said it would increase its military activity around Taiwan after the Speaker of the House of Representatives became the highest level US official to visit the territory in decades.

Several Chinese fighter jets flew close to the median line that divides the Taiwan Strait, while Russia accused the US of “provoking” Beijing.

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