TREASURIES-Yields retreat after Powell testimony

BY Reuters | ECONOMIC | 01/11/22 03:13 PM EST

By Karen Brettell and Chuck Mikolajczak

NEW YORK, Jan 11 (Reuters) - U.S. Treasury yields dipped on Tuesday, with short-dated yields pulling back from near two-year highs following comments from Federal Reserve Chair Jerome Powell on how the central bank plans to combat inflation.

Powell said in a congressional hearing that the economy should be able to handle the current surge in COVID-19 cases with only "short-lived" impacts and was strong enough to handle the start of tighter monetary policy with the central bank poised to raise interest rates and unwind its balance sheet.

"He solidified March as the time when Fed asset purchases would conclude," said Bill Merz, head of fixed income research at U.S. Bank Wealth Management in Minneapolis.

"Second, he both affirmed hawkish points made in the December meeting minutes and did not push back on other Fed members' comments in the last 48 hours that noted March as an appropriate time to begin hiking rates. Going forward, a major question besides rate hikes will be the timing, speed and magnitude of quantitative tightening, which could act as a key driver of higher longer-term bond yields."

The yield on 10-year Treasury notes was down 3.4 basis points to 1.746%.

Benchmark 10-year yields dipped as more aggressive rate hikes are also seen as likely to dent growth and inflation longer-term. The yield had reached 1.808% on Monday, it's highest since January 21, 2020.

Yields had moved higher last week as the central bank was viewed as being more aggressive than previously expected after minutes from the Fed's December meeting released showed the Fed may need to raise rates and reduce its overall asset holdings sooner to fight unabated inflation.

At the same time, the labor market is nearing maximum employment, adding to the case for tightening policy.

Prior to Powell's testimony, Atlanta Fed President Raphael Bostic said high inflation and a strong recovery will require the Federal Reserve to raise interest rates at least three times this year, beginning as soon as March, and warrant a rapid rundown of Fed asset holdings to draw excess cash out of the financial system.

Echoing Bostic, Cleveland Fed President Loretta Mester said the Fed may need to raise rates at least three times this year and begin running down its balance sheet while Kansas City Fed President Esther George said the central bank should begin to trim its holdings "earlier rather than later."

The two-year U.S. Treasury yield, which typically moves in step with interest rate expectations, was down 0.5 basis points at 0.899% after climbing to 0.945%, the highest since February 2020.

A closely watched part of the U.S. Treasury yield curve measuring the gap between yields on two- and 10-year Treasury notes, seen as an indicator of economic expectations, was at 84.5 basis points after flattening to 82.5, the smallest gap since January 3.

A Treasury auction of $52 billion in three-year debt on Tuesday was strong, according to analysts, the first sale of $110 billion in coupon-bearing supply this week.

The three-year U.S. Treasury yield was down 1.4 basis points at 1.185% in the wake of the auction, after earlier climbing to 1.237%, the highest since February 25, 2020.

Treasury will also sell $36 billion in 10-year notes on Wednesday and $22 billion in 30-year bonds on Thursday.

The 10-year auction will come after consumer price inflation data on Wednesday is expected to show that prices rose 0.3% in December, with an annual increase of 6.6%, according to the median estimates of economists polled by Reuters. (Editing by Howard Goller and Cynthia Osterman)

In general the bond market is volatile, and fixed income securities carry interest rate risk. (As interest rates rise, bond prices usually fall, and vice versa. This effect is usually more pronounced for longer-term securities.) Fixed income securities also carry inflation risk and credit and default risks for both issuers and counterparties. Unlike individual bonds, most bond funds do not have a maturity date, so avoiding losses caused by price volatility by holding them until maturity is not possible.

Lower-quality debt securities generally offer higher yields, but also involve greater risk of default or price changes due to potential changes in the credit quality of the issuer. Any fixed income security sold or redeemed prior to maturity may be subject to loss.

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