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Treasury yields fell on Tuesday but easing concerns over a possible technical U.S. default and signs of sticky inflation still left traders pricing in a likely interest rate hike by the Federal Reserve next month.
What’s happening
-
The yield on the 2-year Treasury
TMUBMUSD02Y,
4.555%
slipped by 4.1 basis points to 4.523%. -
The yield on the 10-year Treasury
TMUBMUSD10Y,
3.748%
retreated 7.7 basis points to 3.729%. -
The yield on the 30-year Treasury
TMUBMUSD30Y,
3.931%
fell 6.5 basis points to 3.896%.
What’s driving markets
Yields on short-term Treasury bills were falling Tuesday as news over the weekend of a debt-ceiling deal eased fears that the U.S. government may technically default.
The yield on the 1-month T-bill maturing June 1st, which was considered particularly at risk of default, was trading around 5.5%, down from about 7% last week, according to Bloomberg.
The moves are helping suppress yields across the curve after they rose on Friday in the wake of the PCE inflation report for April that suggested price pressures remained stubbornly high.
Investors are consequently now betting that the Federal Reserve will soon tighten monetary policy further.
Markets are pricing in a 61% probability that the Fed will raise its policy interest rates by 25 basis points to a range of 5.25% to 5.50% after its meeting on June 14, according to the CME FedWatch tool. A week ago the chances of such a hike were priced at 28%.
The central bank is expected to take its Fed funds rate target back down to 5.03% by December, according to 30-day Fed Funds futures.
What are analysts saying
“With a deal to raise the debt ceiling largely priced-in by the end of last week, markets will begin to focus a bit more on the near-term consequence of the debt ceiling suspension: a rising Treasury cash balance that drains liquidity,” said Andrew Hollenhorst, economist at Citi.
“Treasury will need to issue about $500 billion in total T-bills to bring its cash balance back up to above $500 billion, a more comfortable level. The rise in Treasury cash balance means the same amount of drain from either bank reserves or money fund reverse repo balances. The most relevant comparison period is 2021 when most of the drain came from bank reserves. That increases our concern that reverse repo balances will be relatively ‘sticky’ and some banks may have to pay-up to maintain deposits liabilities and reserve assets.”
“In 2021 the cash balance increase occurred over a relatively short two-month period, but Treasury could potentially extend that timeline if they are concerned about rapidly draining liquidity shortly after a period of banking sector instability.” Hollenhorst concluded.
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