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Bond Report: Treasury yields hold steady as bund yields jump on ECB speculation

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U.S. bond yields were little changed to slightly higher Tuesday morning, as investors waited for next week’s interest rate decision by the Federal Reserve.

What’s happening

The yield on the 2-year Treasury
TMUBMUSD02Y,
3.183%

was up at 3.183% versus 3.160% late Monday.

The yield on the 10-year Treasury
TMUBMUSD10Y,
3.006%

rose to 2.987% from 2.959% as of Monday afternoon.

The yield on the 30-year Treasury
TMUBMUSD30Y,
3.164%

advanced to 3.149% from 3.134% on Monday.

What’s driving markets

The Federal Reserve is in its media blackout period ahead of its FOMC meeting next week. After some volatility last week, when a 41-year high U.S. inflation reading prompted investors to price in an imminent full percentage point rate hike in borrowing costs by the central bank, action has settled down.

Markets are now suggesting just a 33% probability that the Fed will raise interest rates by 100 basis points to a range of 2.50% to 2.75% at its July 26-27 meeting. The chances of another 75 basis point move are 67%. The central bank is mostly expected to take its borrowing costs to 3.5%-3.75% by February 2023, according to the CME FedWatch Tool.

The U.S. economic calendar was relatively light on Tuesday, with data showing that U.S. housing starts fell in June for the second straight month and building permits for new homes also dropped.

Meanwhile, Europe took the spotlight after reports that the European Central Bank may be considering a possible 50 basis point increase in borrowing costs on Thursday, to tackle record eurozone inflation of 8.6%.

Until now, investors had considered just a 25 basis point hike was likely, taking the policy rate to minus 0.25%. And the possible acceleration of ECB monetary tightening speaks to the concern in the market that central banks will need to become more hawkish as they struggle to contain rampant price rises.

The policy-sensitive 2-year German bond yield
TMBMKDE-02Y,
0.626%

jumped 9.5 basis points to 0.604% and the euro
EURUSD,
+1.04%
,
which last week hit a 20-year low below parity with the dollar, surged 1% to $1.0245.

What analysts are saying

“With the Fed widely expected to raise rates by 75bps again next week, the latest round of housing data provided further evidence that their tightening cycle is beginning to have a significant impact, with the NAHB housing market index plummeting to 55 in July (vs. 65 expected),” Deutsche Bank’s head of thematic research, Jim Reid, and others wrote in a note.

“That’s the worst reading for the index since the initial wave of the Covid pandemic in May 2020, and if you exclude the pandemic plunge, you’ve got to go back to early 2015 for the last time that sentiment was worse,” they said.

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