Aggressive Fed Moves Back In Play as Yields Surge On CPI Shock

(Bloomberg) -- Investors rushed to price in more aggressive Federal Reserve rate hikes Monday as the US inflation shock continued to upend bets on peak price pressures, sending Treasury yields surging and strengthening the dollar.

With a 50 basis point hike seen as a given at the central bank's policy decision Wednesday, market participants are awaiting its updated projections for the US economy, inflation and interest rates. Traders see 50-50 odds of the Fed raising rates by three-quarters of a percentage point in July, while Barclays Plc became the first major bank to predict such a move could even come this week.

Two-year Treasury yields climbed to a 15-year high of 3.19% and the 10-year equivalent added as much as 4 basis points to 3.20%. Data Friday showed that US May consumer prices exceeded even the highest economist estimate in a Bloomberg survey.

“Peak inflation expectations were building into the inflation release last Friday and the fact that price pressures didn't ease and accelerate further instead have re-jigged market positioning,” said Winson Phoon, head of fixed income research at Maybank Securities in Singapore. “A 75-basis point hike at the FOMC meeting this week can't be ruled out as the urgency to bring price pressures under control has likely increased and an extraordinary situation may require extraordinary measures.”

The deepening sell-off in Treasuries reverberated through Asian markets, with Japan's 10-year yield breaching the 0.25% ceiling that the nation's central bank tolerates. Similar-tenor yields in New Zealand climbed above 4% for the first time since 2014.

Treasuries Dare Fed to Step Up Hikes or Risk Inflation Defeat

Treasuries are also sending a grim message to the Fed that its efforts to catch up with inflation will increase the prospect of a hard landing for the US economy. The signal comes in the form of shrinking gaps between short- and long-maturity yields, including an re-inverted curve between the five- and 30-year yields.

The dollar rose against every peer on Monday on the climb in yields and as investors rushed to buy the haven asset. 

All eyes will be on this week's Fed statement and Chair Jerome Powell's post-meeting press conference, where policy makers' characterization of inflation and long-term forecasts for the fed funds target -- the so-called dot plot -- will be critical. 

While he pushed back against a 75 basis-point hike at the May meeting after his St. Louis Fed colleague James Bullard said that might be worth considering, Powell has not taken anything permanently off the table and has stressed the need for policy to be nimble.

Hedge Fund Bond Bears Timed US Inflation Shock to Perfection

Meanwhile, hedge funds timed their bond bets to perfection, turning bears on every single Treasury futures contract tracked by Bloomberg, right before the shock inflation print sent debt markets tumbling. Leveraged fund net positions flipped negative on two-year Treasury futures last week, having done the same for benchmark contracts the week before, according to the latest Commodity Futures Trading Commission data.

(Updates throughout.)

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