U.S. Treasury Yields Rise as Wage Growth Backs Bets on March Fed Hike

(Bloomberg) -- The U.S. 10-year note's yield extended its climb, reaching the highest level in nearly two years, after December employment data showing strong wage growth fanned inflationary concerns and solidified March as the likely starting point for the first rate hike by the Federal Reserve.

While the 199,000 new jobs fell short of the expected 450,000 jump, wages for the past 12 months expanded at 4.7%, eclipsing an expected pace of 4.2%. The unemployment rate declined to 3.9%, below the forecast of 4.1%.

The rapid wage growth underscored the case for a more aggressive tightening by the Fed and capped a punishing week in the bond market. The five-year note's yield rose as much as 5.5 basis points to 1.52%, its highest level since early 2020, and ended the day around 1.50%. As yields across the curve continued their march higher, the 10-year note's rose above 1.79%, exceeding last year's peak. At the New York close it was 1.76%, more than four basis points higher on the day and 26 basis points higher on the week, the biggest increase in more than two years.

“This is an inflation story and the curve is responding by bear steepening,” said Subadra Rajappa, head of U.S. rates strategy at Societe Generale. “The Fed likely ignores the headline miss in the context of the unemployment rate declining to 3.9% and eye-popping wage increase of 0.6% month-over-month.”

The bond market has been hit hard by waves of selling during the first week of the new year, and short-dated benchmark yields have climbed to their highest levels since early 2020. The 10-year note yield has surged from 1.51%, while the real or inflation-adjusted 10-year yield has risen rapidly from minus 1.10% to minus 0.77%, its highest level since last June. The moves reflect expectations for a more hawkish Fed policy stance that includes implementing rate hikes and shrinking its balance sheet sooner than previously expected by investors.

The swaps market is now pricing in an approximately 84% chance of a 25-basis-point hike in March after previously seeing a first move more likely in May. The odds approached 90% in U.S. trading Friday.

Higher short-dated Treasury yields are driven by rate-hike expectations, but upward pressure on long-dated maturities also reflects the prospect of the Fed being more active and potentially raising their overnight rate well beyond 2% during the tightening cycle.

“The Fed has flipped the policy script from a focus on full employment to addressing inflation,” said Rob Waldner, chief fixed income strategist at Invesco. “They will act and be more aggressive this year. We expect rates will go higher and the 10-year can rise a little above 2% during the first quarter.”