Bond Report: Two-year Treasury yields end at 3-month highs as investors eye approaching Fed decision

What happened

• The yield on the 2-year Treasury
  TMUBMUSD02Y,
  4.606%
  advanced 8.7 basis points to 4.604% Friday, the highest since March 9. For the week, it was up 10.3 basis points, according to Dow Jones Market Data.

• The yield on the 10-year Treasury
  TMUBMUSD10Y,
  3.742%
  gained 3 basis points to 3.744%, and it rose by 5.3 basis points this week.

• The yield on the 30-year Treasury
  TMUBMUSD30Y,
  3.883%
  added less than 1 basis point to 3.886%. For the week, it rose 0.4 basis point, according to Dow Jones Market Data.

What drove markets

With no notable U.S. economic releases Friday, focus in the bond market was on next Tuesday’s inflation data for May and Wednesday’s Federal Reserve monetary policy decision.

Markets are pricing in a 71.2% probability that the Fed will leave interest rates unchanged at a range of 5.0% to 5.25% after its meeting on June 14, according to the CME FedWatch tool. The chances of a 25 basis point hike to 5.25% to 5.50% in July was priced at 53%.

The ICE BofAML MOVE index, which measures expected volatility in the Treasury market, settled at 115.77 on Friday, after logging its lowest close since Feb. 17 earlier this week, according to Dow Jones Market Data.

In March, the measure of bond-market volatility jumped to the highest levels since the 2008 financial crisis in the wake of regional bank failures.

What analysts said

While financial markets were betting the Federal Reserve will likely take a breather from its tightening campaign and “skip” an interest-rate hike when it meets next week, some market strategists still think a 25-basis-point rate hike is possible.

“Next week’s decision is likely to come down to the wire, but we maintain our long-held view that the Fed will tighten rates by a final 25 basis points in June to a range of 5.25%-5.50%,” said strategists at TD Securities led by Oscar Munoz, chief U.S. macro strategist.

“If the Fed decides to ‘skip’ the June meeting, we expect the decision to be accompanied by communication that leans hawkish, signaling a likely hike for July,” they added.

Treasurys are likely to bear flatten sharply in the event of a rate hike as the market pencils in the potential for more hikes in July, they said. However, if the Fed passes on a hike, Munoz and his team expect the curve to bull steepen sharply even if the Fed continues to insist that they are not finished tightening yet.