(Bloomberg) — Treasury yields climbed Wednesday — some to the highest levels in a week — as traders priced in higher odds of a Federal Reserve interest-rate increase this year after a gauge of service-sector activity was stronger than anticipated.
The market-implied odds of a quarter-point Fed rate increase in November climbed to around 60%, from closer to 50%, after the August ISM services index and related measures of prices and employment rose sharply. The odds of a hike that month peaked at around 75% last week.
Short-dated Treasury yields, more sensitive than longer maturities to changes in the Fed’s rate, remained several basis points higher on the day. The two-year rose as much as 7 basis points to 5.03%, with the front-end bearing the brunt of selling amid concern inflation may be on the cusp of picking up.
With the headline ISM reading showing the strongest pace of expansion for services since February, attention also focused on the prices paid sub-index that rose for a second month, after falling steadily over the preceding 18 months. The trend reversal comes as oil prices have risen sharply over the past two weeks to the highest levels since November amid increasing demand and a prolonged production cut from Saudi Arabia.
ISM prices paid “appears to have bottomed,” and “in conjunction with oil prices moving higher will be watched closely,” said Gregory Faranello, head of US rates trading and strategy for AmeriVet Securities. “A continued move higher in oil from here will garner attention from the Fed and markets.”
The key reading on inflation next week will also be in focus ahead of the Fed’s policy meeting on Sept. 19-20. While the swaps market is pricing little prospect of a rate hike this month, the central bank is due to release its quarterly summary of economic projections and estimate of the rate policy path, known as the dot plot.
The resilient US economy suggests officials will upgrade their growth forecasts and the market expects some risk that the Fed will reinforce a commitment to keep policy tight for an extended period by reducing the number of forecast cuts in 2024. The current dot plot signals another rate hike by the end of the year before an easing in 2024.
“The Fed appears intent on a skip this month,” and “any stronger and better data is likely reflected in the likelihood for another 25 basis points in November,” Faranello said.
Boston Fed President Susan Collins said Wednesday policymakers will need to be patient as they assess economic data to figure out their next steps and that further tightening may still be required. The remarks by Collins, who doesn’t vote on monetary policy this year, suggest she would support holding rates steady this month. Fed Governor Christopher Waller said a day earlier policymakers can afford to “proceed carefully” with interest-rate increases given recent data showing inflation continuing to ease.
The prospect of additional tightening by the Fed later this year, twisted the yield curve flatter as longer-dated Treasury yields lagged the selloff. The 10-year was higher by 3 basis points at 4.29%, while the 30-year yield was down 1 basis points at 4.36%.
In addition to the stronger-than-expected economic data, Treasuries have also come under pressure from a swath of corporate issuance following the Labor Day holiday. After companies kicked off the week with $36 billion of debt sale on Tuesday, about nine potential issuers are looking to sell new US investment-grade bonds on Wednesday, and that was set to boost issuance to meet consensus projections of around $50 billion for the week.
“Once the dust settles we expect investors’ attention will return to the corporate issuance calendar with the bearish implications that holds for Treasuries,” Ben Jeffery, strategist at BMO Capital Markets wrote in a note.
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