TREASURIES-U.S. Treasuries sell off amid Fed tough talk, growing de-risk mood

BY Reuters | ECONOMIC | 09/29/22 04:09 PM EDT
    (Adds new comment, fresh prices)
    By Herbert Lash
       NEW YORK, Sept 29 (Reuters) - U.S. Treasuries resumed a sell-off on
Thursday as Federal Reserve officials reaffirmed the U.S. central bank's plans
to tame inflation by aggressively hiking interest rates, an outlook that
deepened a risk-off mood in capital markets.
    Markets are in flux after the new British government's plans last week to
drive growth through huge tax cuts sent bond yields higher and caused the pound
to plunge. The turmoil further unsettled investors already concerned about
inflation and rising rates.
    "The markets are pretty fragile here at this point," said Tom di Galoma,
managing director at Seaport Global Holdings LLC.
    "People are really worried about liquidity and liquidity in pretty much all
markets, whether it's forex, whether it's swaps or rates, and it's playing into
the credit market," he said.
    With the war in Ukraine raging and winter fast approaching, investors are
trying to de-risk portfolios as the third-quarter ends and the fourth quarter
begins, di Galoma said.
    Any hope that a more accommodative path to tackling inflation might be in
store was not apparent from Fed officials.
    Cleveland Fed President Loretta Mester said she does not see distress in
U.S. financial markets that would alter the central bank's campaign to lower
inflation through rate hikes that have taken the fed funds rate to a range of
3.0% to 3.25%.
    Mester told CNBC that she still sees inflation as the paramount problem
facing the U.S. economy, which means the Fed needs to press forward with hiking
rates to lift the federal funds target rate to over 4%.
    "We're not at a point where we should think about stopping on rate hikes,"
Mester said. "We're still not even in restrictive territory on the funds rate."
    St. Louis Fed President James Bullard said rates will probably need to be
"higher for longer" than markets previously anticipated and that a sharp
downtown was not envisioned.
    "We are at higher recession risk, but that's not the base case at this
point," Bullard told reporters on a conference call.
    The two-year Treasury yield, which typically moves in step with
rate expectations, was up 8.6 basis points at 4.180%, while the yield on
benchmark 10-year notes rose 5.4 basis points to 3.761%.
    The 10-year's yield on Wednesday fell 25.6 basis points to 3.707%, its
biggest single-day drop since March 2009 in reaction to the Bank of England's
intervention to halt the plunge in bonds and sterling's weakening.
    The BoE said it would buy long-dated gilts to restore financial market
stability, a move that could lead the Fed to halt its balance sheet reduction to
avert a hard U.S. landing, said Joe LaVorgna, chief U.S. economist at SMBC Nikko
Securities in New York.
    The Fed is reducing its balance sheet by $60 billion of Treasuries every
month, which is drying up liquidity. By stopping the runoff, rates could go
higher and faster, in line with Fed plans to quickly stanch inflation, LaVorgna
said.
    "It seems to me the Bank of England may have a little bit of a template on
how in the Fed's mind it may be able to get the funds rate higher," he said.
    "It is conceivable the Fed could take the playbook out of BoE, the playbook
in that in light of market conditions we're either going to slow or temporarily
pause on balance sheet reduction," LaVorgna said.
    The gap between yields on two- and 10-year Treasuries, seen as
a recession harbinger, steepened at -42.1 basis points.
    The 30-year yield was up 1.9 basis points to 3.700%.
    The breakeven rate on five-year U.S. Treasury Inflation-Protected Securities
(TIPS) was last at 2.234%.
    The 10-year TIPS breakeven rate continued to decline and was
last at 2.184%, indicating the market sees inflation averaging just under 2.2% a
year for the next decade. The rate has fallen from about 2.64% five weeks ago.
    The U.S. dollar five-years forward inflation-linked swap, seen
by some as a better gauge of inflation expectations due to possible distortions
caused by the Fed's quantitative easing, was last at 2.256%.
     Sept. 29 Thursday 3:56 PM New York / 1956 GMT
                                               Price        Current   Net
                                                            Yield %   Change
                                                                      (bps)
 Three-month bills                             3.255        3.3273    -0.047
 Six-month bills                               3.7775       3.9041    -0.014
 Two-year note                                 100-34/256   4.1801    0.086
 Three-year note                               98-20/256    4.1971    0.075
 Five-year note                                100-146/256  3.998     0.076
 Seven-year note                               99-216/256   3.9007    0.076
 10-year note                                  91-184/256   3.7614    0.054
 20-year bond                                  91-108/256   4.0048    0.020
 30-year bond                                  87-104/256   3.7       0.019

   DOLLAR SWAP SPREADS
                                               Last (bps)   Net
                                                            Change
                                                            (bps)
 U.S. 2-year dollar swap spread                 29.00        -2.00
 U.S. 3-year dollar swap spread                  7.25        -0.75
 U.S. 5-year dollar swap spread                  4.75        -0.25
 U.S. 10-year dollar swap spread                 4.50        -0.25
 U.S. 30-year dollar swap spread               -41.75        -0.75

 (Reporting by Herbert Lash
Editing by Nick Zieminski, Leslie Adler and Jonathan Oatis)

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.

Before investing, consider the funds' investment objectives, risks, charges, and expenses. Contact Fidelity for a prospectus or, if available, a summary prospectus containing this information. Read it carefully.

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