Hawkish comments from Fed officials cause government bond yields to jump

Several Federal Reserve officials on Tuesday indicated that the US central bank is committed to its aggressive fight against rising prices, leading to a jump in short-term government bond yields as investors priced in more rate hikes.

The two-year yield, which moves in line with interest rate expectations, rose by 0.19 percentage point to 3.06 percent, the largest daily movement since mid-June. The three-year interest rate rose by 0.22 percentage point, also the largest move since mid-June, to above 3 percent.

The president of the San Francisco Fed, Mary Daly, said in an interview on LinkedIn that the central bank was “far from done” with its battle to cool inflation, which is still at a 40-year high.

Her comments come after the Fed’s meeting last week, where Chairman Jay Powell suggested it might be appropriate to slow the pace of rate hikes, prompting some relief in markets.

In a separate interview on Tuesday, Chicago Fed President Charles Evans said he thought a 0.5 percentage point increase at the next meeting in September was appropriate. However, he left the door open to a larger 0.75 percentage point increase, which he said “could also be good”.

Also on Tuesday, Cleveland Fed president Loretta Mester said in an interview with The Washington Post that she expects below-trend economic growth this year, which she says is necessary to curb inflation. She did not believe the US was in recession, given the continued strength of the labor market. Mester is known for being one of the more aggressive members of the Federal Open Market Committee.

Subadra Rajappa, head of US interest rate strategy at Société Générale, said Daly’s comments had “lured” the sell-off in the US treasury market, where yields move inversely to prices. “It’s hard to know. . . if the market is just overreacting,” Rajappa added.

Tom Simons, a money market economist at Jefferies, said Evans “tends to be very dovish, so this aggressive tone is important”.

After the FOMC meeting in July, investors began to estimate a series of smaller rate hikes later this year amid signs that the Fed’s aggressive monetary tightening was beginning to cool US economic growth.

But the comments from Daly, Evans and Mester sparked futures markets, with expectations of where the Fed’s key rate will be in December rising from 3.27 percent on Monday to 3.39 percent on Tuesday.

The Fed’s comments come after the trade department reported last week that the US economy contracted for the second consecutive quarter and met one of the general criteria for a recession. It shrank 0.9 percent year-on-year in the second quarter, after contracting 1.6 percent in the first three months of 2022.

Investors also warned that liquidity in the Treasury market — the ease with which traders can buy and sell — is poor, with many market participants taking a vacation this month. A deterioration in liquidity can lead to large fluctuations in the price of securities.

Elsewhere, US stocks fell Tuesday as Nancy Pelosi’s arrival in Taiwan fueled tensions between the US and China.

Wall Street’s S&P 500 stock index closed the day 0.7 percent lower, while the tech-heavy Nasdaq Composite fell 0.2 percent. Europe’s Stoxx 600 fell 0.3 percent, Japan’s Nikkei 1.4 percent, Hong Kong’s Hang Seng 2.4 percent and the CSI 300 index of mainland Chinese companies fell 1.9 percent.

China said it would ramp up its military activities around Taiwan after the Speaker of the House of Representatives became the highest-ranking US official to visit the area in decades.

Several Chinese fighter jets flew close to the median line separating the Taiwan Strait, while Russia accused the US of “provoking” Beijing.

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