By Karen Brettell
(Reuters) - Benchmark 10-year Treasury yields hit their highest level since 2011 on Monday, and a key part of the yield curve inverted for the first time since April as investors braced for the prospect that the Federal Reserve’s attempts to stem soaring inflation will dent the economy.
Yields jumped after data on Friday showed that U.S. consumer prices accelerated in May as gasoline prices hit a record high and the cost of food soared, leading to the largest annual increase in nearly 40-1/2 years.
The Fed is expected to hike rates by 50 basis points when it concludes its two-day meeting on Wednesday, with traders now seeing a 75 basis point increase as having a 21% probability.
UBS strategist Rohan Khanna said hawkish European Central Bank communication alongside the inflation print "have completely shattered this idea that the Fed may not deliver 75 bps or that other central banks will move in a gradual pace."
Investors expect that the Fed will hike interest rates higher than previously expected this cycle as it tackles stubbornly high prices pressures.
Fed funds futures traders now expect the Fed’s benchmark rate to rise to 3.97% by May, around 1 percentage point higher than was expected last month, and up from 0.83% now.
Deutsche Bank said it now sees rates peaking at 4.125% in mid-2023.
As the Fed tightens policy, nerves about an economic downturn are rising. The two-year, 10-year Treasury yield curve briefly inverted on Monday, a reliable indicator that a recession will follow in one to two years.
Jim Vogel, an interest rate strategist at FHN Financial, however, said a recession is not currently priced into the market.
“There is a fear that the Fed or any central bank can tighten us into a global slump, but not an outright recession, elsewise the peak of the Treasury curve wouldn’t be the five-year, it would be the two-year,” Vogel said.
Two-year yields reached 3.283%, the highest since December 2007. Five-year yields rose to 3.489%, the highest since July 2008, Benchmark 10-year yields hit 3.381%, the highest since April 2011.
The yield curve between two-year and 10-year notes inverted as far as 2 basis points, before rebounding to positive territory at 9 basis points. The gap between two-year and five-year note yields remained positive at 21 basis points.
The curve between five-year and 30-year yields inverted by as much as 17 basis points, after reinverting on Friday for the first time since May 4.
Uncertainty over how much higher the Fed will hike rates in the coming months dented demand for a $45 billion sale of three-month bills on Monday.
"The 3-month auction was historically awful," Jefferies economists Thomas Simons and Aneta Markowska said in a note.
The bills sold at a high yield of 1.640%, 9 basis points above where they had traded before the sale.
That is the widest tail since Lehman Brothers filed for bankruptcy on Sept. 15, 2008. Demand was 2.27 times the amount of bills on offer, which was the worst since April 21, 2008, Jefferies said.
An auction of $42 billion in six-month bills saw better interest, however.
The bills sold at a high yield of 2.160%, 2-1/2 basis points below where they traded before the auction. The bid-to-cover ratio was 3.26 times, the most since April.
"The issue with the Fed front-loading the rate hikes has a much bigger impact on the 3-month than the 6-month since the total number of rate hikes has not increased, it is just the pace that we get there," Jefferies said.
June 13 Monday 3:12PM New York / 1912 GMT
Price Current Net
Yield % Change
Three-month bills 1.53 1.5569 0.194
Six-month bills 2.1075 2.1591 0.199
Two-year note 98-137/256 3.2767 0.228
Three-year note 98-86/256 3.4638 0.239
Five-year note 96-30/256 3.4837 0.231
Seven-year note 95-158/256 3.4638 0.224
10-year note 95-208/256 3.3751 0.218
20-year bond 94-116/256 3.6439 0.194
30-year bond 90-160/256 3.3751 0.177
DOLLAR SWAP SPREADS
Last (bps) Net
U.S. 2-year dollar swap 38.00 1.00
U.S. 3-year dollar swap 18.00 -0.50
U.S. 5-year dollar swap 4.50 0.50
U.S. 10-year dollar swap 6.50 0.50
U.S. 30-year dollar swap -24.75 -0.25
(Reporting by Karen Brettell; Additional reporting by Yoruk Bahceli and Sujata Rao in London; Editing by Angus MacSwan and Jonathan Oatis)