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Bond Report: 10-year Treasury yield holds steady near 2.8% as traders scale back expectations for 2022 Fed rate hikes

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Treasury yields turned mostly higher Thursday as traders pared their outlook for more Federal Reserve interest rate hikes after revised data showed that the U.S. economy contracted by a deeper-than-expected 1.5% annual rate in the first quarter.

The 2-year yield, which is mostly associated with the path of near-term Fed policy, fell. Meanwhile, yields along the rest of the curve rose as a reflection of the view that policy makers might not need to keep delivering aggressive rate hikes through year-end that could send the economy into a recession.

What yields are doing

The 10-year Treasury note yield
TMUBMUSD10Y,
2.754%

was at 2.782% versus 2.746% at 3 p.m. Eastern on Wednesday.

The yield on the 2-year Treasury note
TMUBMUSD02Y,
2.492%

was at 2.472% versus 2.50% Wednesday afternoon.

The 30-year Treasury bond yield
TMUBMUSD30Y,
2.985%

was at 3.01% compared with 2.965% late Wednesday.

What’s driving the market

Revised data released Thursday shows that the U.S. economy contracted by a deeper-than-expected 1.5% annual pace in the first quarter, largely because of a record trade deficit. That compares with a previously estimated 1.4% drop-off. Corporate profits fell for the first time in five quarters.

Meanwhile, U.S. jobless claims fell by 8,000 last week to 210,000, signaling that layoffs remain extremely low. Economists polled by The Wall Street Journal had expected claims to total 215,000 in the seven days that ended May 21. And an index of pending home sales slumped 3.9% in April and fell for the sixth month in a row, signaling a sharp slowdown in the real estate market.

Financial markets appeared to conclude from the GDP report that the central bank could back off somewhat on continued aggressive rate increases with all three major stock indexes moving higher on Thursday.

Fed-funds futures traders pulled back on their expectations for continued rate hikes. They’re now placing a 56% chance on the fed-funds rate target getting between 2.5% and 2.75% by December, up from 35% a week ago, according to the CME FedWatch Tool. The likelihood that policy makers will get to a target between 2.75% and 3% by year-end, from a current level between 0.75% and 1%, dropped to 32% from 51% on May 19.

The Fed, which is set to begin unwinding its balance sheet on June 1, delivered a half percentage point rate increase on May 4 following a more traditional quarter-point, or 25 basis point, hike earlier this year. Fed officials previously signaled at least two more half-point rises are in store.

Friday will bring a look at the Fed’s preferred inflation indicator, the core personal-consumption expenditures inflation reading.

What analysts are saying

“The profits drop is a reminder that while most economists, including the Fed staff and FOMC participants, dismissed the contraction in the economy as anomalous or caused by frequently volatile factors or otherwise not important, it was nonetheless real,” said Chris Low, chief economist at FHN Financial. “The drop in corporate profits underscores the reality of the output drop. It reflected a slowdown in inventory investment and weakness overseas, but it was nevertheless real enough to undermine profitability.”

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