Two-year Treasury yields hold near three-month highs

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U.S. bond yields held recent highs Thursday as investors reassessed Federal Reserve policy trajectory following interest rate rises by central banks in Australia and Canada.

What’s happening

What’s driving markets

Two-year Treasury yields were hovering near their highest in three months amid renewed concerns that the Federal Reserve may keep interest rates higher for longer.

The shift up in short-term yields follows a surprise increase in borrowing costs on Wednesday by the Bank of Canada as it continues to battle stubbornly high inflation.

The BoC move has reminded investors that even if the Fed pauses its tightening cycle after its policy meeting next week, it may still need to resume raising interest rates should inflation not decline quick enough from the current 4.9% to its 2% target.

The U.S. consumer price index inflation report for May is due on Tuesday.

Markets are pricing in a 70% probability that the Fed will leave interest rates unchanged at a range of 5.0% to 5.25% after its meeting on June 14, according to the CME FedWatch tool.

However, the chances of an additional 25 basis point rate increase in July has risen to 51%, up from just 10% a month ago. And whereas a few months ago the Fed was expected to have begun cutting rates from current levels by the autumn, the market is now pricing in no such reduction until next year.

U.S. economic updates set for release on Thursday include the weekly initial jobless claims report at 8:30 a.m. and April wholesale inventories data at 10 a.m., both times Eastern.

At 11:30 a.m. ET the US Treasury will sell $60 billion 4-week and $50 billion 8-week bills as it begins to refill its coffers after Congress lifted the federal debt ceiling last week.

What are analysts saying

“With less than a week to go until the Fed’s next decision, [Wednesday] offered another hawkish surprise for markets after the Bank of Canada delivered an unexpected 25bp rate hike. Now that might be just one central bank, but it comes on the back of a similar surprise hike from the Reserve Bank of Australia the previous day, so investors are starting to see a pattern emerging here and there was a significant bond selloff as a result,” said Henry Allen, strategist at Deutsche Bank.

“The latest developments have also run against the prevailing narrative that central banks are on the verge of pausing their rate hikes, particularly given Canada was one of the first to formally signal a pause back in January. The big question now is whether the Fed might follow up with a hike of their own next Wednesday, or whether they’ll finally keep rates on hold after 10 consecutive increases,” Allen added.

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