Treasury futures point to another jump in yields after hot October inflation

Futures moved while cash Treasuries were off

U.S. government bond trading in the cash market was closed Wednesday for the Veterans Day bank holiday, but futures and stocks kept going. Treasury contracts fell, pointing to a 2 to 4 basis point lift in yields when trading reopens.

Those declines suggest the 10 year could retest Tuesday's peak above 5.01%. Also on Tuesday, the sale of new 10 year notes became the first since 2006 to lock in a fixed rate of at least 5%.

Traders were unwinding haven bets, with notable selling of bullish positions in Treasury futures. The interest rate options market stayed active, with activity focused on hedging for more Federal Reserve tightening showing up in Secured Overnight Financing Rate futures.

Why the market is leaning toward more Fed hikes

October inflation ran hotter than economists expected, and that set off a reset in rate expectations. Markets fully priced a quarter-point increase for the Dec. 9 Fed meeting after CPI and core CPI beat estimates. Strong October employment figures published Nov. 6, plus earlier hawkish remarks from policymakers, had already nudged expectations higher.

At UBS, Sonja Laud oversees investment operations across Europe, the Middle East and Africa, and she said, "We are realizing inflation is a lot stickier than the market had anticipated." "Now all of a sudden we have to price in a December hike and the market is debating whether it's 25 basis points or 50 basis points."

Fed voices stayed stern. Governor Christopher Waller said a half-point move in December may be needed, and Dallas Fed President Lorie Logan backed at least two more quarter-point increases, potentially at a faster tempo than earlier this fall. Chicago Fed President Austan Goolsbee called the latest inflation report "borderline disturbing," while voting member Anna Paulson warned that elevated inflation is not coming from temporary forces.

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Forecasts shift and odds of a bigger move rise

Banks moved their paths higher. Goldman Sachs added a March increase to a forecast that previously had only December, and Nomura made the same change. Deutsche Bank inserted a January hike on top of moves in December and March. Standard Chartered's strategists said the argument for a half-point in December has grown stronger.

SOFR futures fell Wednesday, reinforcing a quarter-point move on Dec. 9 while putting the probability of a half-point at about 15%. Pricing also implies three quarter-point increases by mid next year. Trades in options included buying structures that would benefit if markets tilt toward a half-point in December.

For context, in September the Fed increased rates by a quarter-point to a 3.75% to 4% target range, and in October it left them unchanged.

Auctions, cross currents and your portfolio

The bond market also has supply to absorb: a $25 billion sale of new 30 year bonds is set for Thursday, encouraging some investors to wait. The new long bond was indicated near 5.35%, and is poised to carry a 5.25% coupon, which would be the highest for a new issue since 2001. By comparison, last month's reopening of an August bond cleared at a higher yield of 5.618%.

Rising oil and stock prices added pressure on Treasuries this week, a reversal from last week when futures got a haven lift as the U.S. midterm outcome hit risk assets. Back then, benchmark oil fell to a two month low and big tech stocks posted their sharpest drop in six years on concerns about a coming shift in congressional control in January.

There is still plenty that could change the path into December. MUFG notes a key payrolls report is on deck and it is unclear if the recent slide in oil will last. If odds of a half-point rise increase, Derek Halpenny, who runs MUFG's research group covering global markets in EMEA, said, "It would alter the current balanced expectations in the markets across key central banks and shift rate hike expectations much more in favor of the dollar." "That would likely prompt a further lurch lower in euro-dollar and bring levels below the 1.1000-level into play."

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