US core yields hit 4% for first time since August on Fed rethink

(Bloomberg) — Core U.S. Treasury yields returned to 4%, a level last seen in August, as a jobs report reduced the likelihood of another big interest rate cut from the Federal Reserve.

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Bonds fell late last week on Monday after surprisingly strong September payrolls data. The 10-year yield rose four basis points to 4.01%, while the two-year yield rose nine basis points to the same level.

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The moves reflect swirling doubts about the Fed's next moves. Money markets no longer see a half-point cut this year, while a quarter-point drop in November that was seen as a certainty is now priced at an 86% probability. For the first time since August 1, the year-end cut is less than 50 basis points

“We expected higher yields but expect some gradual adjustment,” Goldman Sachs Group Inc. strategists including George Cole wrote in a note. “The strength of the September jobs report could accelerate that process, with renewed debate over the extent of policy tightening, and, as a result, the potential depth of Fed cuts.”

With the two-year yield trading above the 10-year rate for the first time since Sept. 18, underperformance in short-dated U.S. Treasuries, which are more sensitive to monetary policy, has inverted a key part of the yield curve again. Historically, the bond yield curve has been upward sloping and long notes have offered higher yields, a norm that was disrupted for about two years as the Fed aggressively raised rates.

European bonds followed US Treasuries lower. German 10-year yields rose four basis points to 2.25%, the highest in a month, while the UK equivalent rose six basis points to 4.19%.

The sell-off after Friday's jobs data is the latest twist in a year that has forced investors to repeatedly revise their expectations for the economy and Fed policy. US services activity also alarmed traders last week, beating all forecasts, and casting further doubt on theories that the economy is deteriorating faster than feared.

Traders now await a series of speeches by Fed policymakers for more clues on the rate path. Minneapolis Fed President Neel Kashkari, Atlanta Fed President Raphael Bostick, St. Louis Fed President Alberto Musallem and Fed Board member Michelle Bowman spoke at various events on Monday.

The market is also awaiting US inflation data later this week. The consumer price index rose 0.1% in September, the smallest gain in three months. Fed Chair Jerome Powell said estimates issued by officials, along with their September rate decision, point to a quarter-point rate cut at the final two meetings of the year.

“It doesn't take a recession to get inflation to bearable levels, so the Fed is easing policy without waiting for real economic weakness,” said Dario Perkins, managing director at TS Lombard. “By now, everyone should have realized that the Fed was cutting rates pre-emptively.”

(Update with curve inversion in fifth paragraph.)

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