Treasury yields near 5% as October inflation lifts rate bets

By Daniel Okafor

The 10-year Treasury yield climbed 12 basis points to 4.99% on Tuesday after the October consumer-price index gained 0.4%, above the 0.3% forecast.

Tuesday’s report showed prices moving higher across broad categories of goods and services. The 10-year rate prices new mortgages, corporate debt and other borrowing, putting those costs back at the edge of 5%. Bond yields surged and stocks slumped after the release, as the data suggested the Federal Reserve might need to tighten more aggressively.

Why did Treasury yields jump?

FactSet data showed the policy-sensitive 2-year Treasury note jumped 19 basis points to 4.75% after the report. The move put it on track for the biggest one-day rise in two years. The 4.75% yield sat above the 4% ceiling of the Fed’s short-term policy range, indicating that more rate increases could follow.

Robert Pavlik, senior portfolio manager at Dakota Wealth Management, said: “We are so heavily dependent on oil around the world to make and do things, it drives everything up.” Pavlik called a half-point increase “irresponsible” because higher rates would not resolve the oil shock from the Iran war.

Pavlik said a jumbo increase would hurt consumers already facing higher borrowing and fuel costs. “I don’t think they should be raising another 25 basis points,” he added.

What did Christopher Waller see?

Fed governor Christopher Waller said in London on Tuesday that he would recommend a half-point increase if core inflation reached 0.3% or more. The October core reading met that threshold, which Waller said would suggest inflation was moving farther from the Fed’s 2% yearly target.

Vincent Ahn, a portfolio manager at SLW Investments, said: “I understand why Waller went there.” His concern was that inflation pass-through would run “bigger and longer than expected,” and Tuesday’s print supported his view.

Ahn said putting a 50-basis-point increase on the table “also does some of the tightening for them.” He also said Tuesday’s surge in the 2-year yield delivered “tightening the Fed did not have to deliver.”

How did traders reprice December?

The CME FedWatch Tool put the probability of a quarter-point December increase above 85%. It assigned nearly 15% to a half-point increase, up from zero a day earlier. Ahn said placing a 50-basis-point move on the table tightened conditions before the Fed acted.

The Fed still had reason to avoid overreacting to one backward-looking data point. Ahn noted that oil can reverse on a headline: “Oil can turn on a headline, but Brent is down more than 20% from its late-October high.” Gas prices also dipped back below $4 a gallon during the week.

“The gas pump is already telling you about November,” Ahn said. He noted that November’s CPI report would land on Dec. 10, the morning after the Fed’s next rate decision, placing a fresh inflation reading beside the policy decision.

Why did stocks retreat?

Stocks opened lower Tuesday, and a broad rotation into everyday stocks paused. A day earlier, the Dow Jones Industrial Average logged another swing of more than 1,000 points as stocks continued to move in wide ranges after the midterm elections. A related MarketWatch report described the volatility as the Dow’s third 1,000-point swing in four days.

FactSet showed the S&P 500 down 0.2%, the Dow down 0.7% and the Nasdaq Composite Index down 0.9% on Tuesday. Schlossberg’s prescription was to wait for pullbacks and favor higher-quality equities in a choppier market.

Gary Schlossberg, global strategist at Wells Fargo Investment Institute, said: “We would be patient and disciplined about buying equities on pullbacks.” He added: “We anticipate a choppier equity market going forward and would focus on higher quality equities,” such as U.S. large-cap stocks in industrials, materials and communication services.

What does Dec. 10 test?

November’s CPI report will test the bond market’s new rate expectations. It lands on Dec. 10, one morning after the Fed’s next decision, while Brent’s retreat from its late-October high and sub-$4 gasoline prices complicate Waller’s argument for another 50-basis-point increase.