Treasury 30-Year Yield Climbs Past 3% Ahead of Fed Rate Decision

(Bloomberg) -- Treasuries extended declines as trading kicked off Tuesday, driving the 10-year yield above 3% as investors brace for the Federal Reserve's biggest interest-rate hike since 2000.

The yield on the 10-year note climbed as much as three basis points, close to Monday's intraday peak of 3.009% that was the highest since December 2018. Australian bonds tumbled to send short-end yields to eight-year highs after the country's central bank raised borrowing costs by more than expected.

The conclusion of the U.S. central bank's meeting on Wednesday is raising the risk of another volatile week in the markets. The Fed is widely expected to increase its key benchmark rate by a half-percentage point and leave the door open for further hikes of that magnitude this year. It will also provide an update when it will start to reduce its bond holdings, a step that will likely pull tens of billions of dollars from the market each month as it allows securities to mature.

“Investors are getting defensive on duration and selling the market ahead of the balance sheet announcement by the Fed,” said John Brady, managing director at RJ O'Brien. “The Fed is clearly headed for a new policy regime now, one where aggressive short-end interest rate hikes will be accompanied by a bond-runoff program that is twice as large as it was in 2017/2018.”

The policy-sensitive two-year U.S. yield rate rose four basis points to 2.77%, resulting in a modestly flatter curve. The rise in long-dated Treasury yields is tightening financial conditions by triggering an increase in borrowing costs for consumer and corporate loans as well. That's reflected in the surge in the yield on 10-year inflation-adjusted Treasuries, which spiked more than 30 basis points since Thursday to stand at 0.17% on Tuesday, the highest since the early months of the pandemic, as falling commodity prices erode demand for the securities.

The 10-year TIPS yield, called a real yield because it represents the rate investors will accept when compensated for inflation, went negative in early 2020 and remained below zero except briefly during the market mayhem that March. A negative real interest rate is a sign of extremely easy financial conditions, since the expected rise in prices would be more than enough to cover the cost of borrowing. The rise in real yields was accompanied by lower market expectations of inflation, a key area of focus for the Fed. The 10-year breakeven was lower by 12 basis points at 2.82%, and extended its drop from its all-time peak of 3.04% last month.

Australian three-year yields rose 19 basis points Tuesday as Reserve Bank of Australia Governor Philip Lowe said he expects further hikes to follow Tuesday's decision to raise the cash-rate target to 0.35%.

The selling pressure in Treasuries this week comes after the bond market registered back-to-back monthly losses of 3.1% in both March and April. Investors are left waiting to see when inflation is showing signs of having peaked and how much the higher rates are cooling down the economy.

“While the Federal Reserve has been ratcheting up its hawkish rhetoric on interest rates in recent months, it will likely begin to recognize the danger of a too-aggressive monetary policy when fading fiscal stimulus and a high dollar are both already applying the brakes to the economy,” said David Kelly, chief global strategist at JPMorgan Asset Management in a note.