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NEW YORK: Treasury yields on Friday edged higher after a red-hot US inflation report the prior day raised market expectations that the Federal Reserve’s target interest rate will peak in 2023 close to 5%.

The two-year notes’ yield, which typically moves in step with interest rate expectations, jumped to a 15-year high of 4.535% on Thursday. It closed lower but on Friday moved up 6 basis points at 4.509%.

The Fed has raised rates at the fastest pace since the 1980s as it seeks to quell inflation running at a four-decade high. Its target rate, or the federal funds rate, has climbed to a range of 3% to 3.25% from near zero in March.

“Clearly (Thursday’s) CPI (Consumer Price Index) reaffirms the Fed’s path on rate hikes for this year. We’re seeing 75 (basis points) the next meeting, 50 in December,” said Subadra Rajappa, head of US rates strategy at Societe Generale.

“The biggest price action in the market was the fact the terminal rate moved up quite meaningfully,” Rajappa added, referring to where the market expects fed funds rates to peak.

Money markets see the fed funds rate at 4.96% in March 2023, about a 25 basis point increase from where they were priced before data on Thursday showed US consumer prices rose more than expected as rents surged.

The University of Michigan’s preliminary October reading of consumer sentiment showed one-year inflation expectations rose to 5.1% from 4.7% last month. The survey’s five-year inflation outlook increased to 2.9% from 2.7% in September.

The market also is now pricing in an 11.3% probability that the Fed will raise rates by a super-sized 100 basis points when policymakers meet Nov. 1-2. The greater likelihood is that it will hike rates by 75 basis points for a fourth straight time.

Blake Gwinn, head of US rates strategy at RBC Capital Markets, said expectations for the terminal rate have moved considerably higher. RBC had expected two to three rate cuts in the second half of 2023 but has pulled that back, Gwinn said.

RBC believes the Fed is shifting its main objective to what the level of rates should be from its current focus on the pace of raising them.

The Fed should raise rates more slowly and steadily to allow time for its policy actions to seep through the economy and minimize market volatility, Kansas City Fed President Esther George said on Friday.

The Treasury Department is asking primary dealers of its securities whether the government should buy back some of those bonds to improve liquidity in the $24 trillion market. Investors are worried about rising bond volatility as the Fed rapidly raises rates.

The gap between yields on two- and 10-year Treasury notes, a harbinger of a looming recession that has been inverted since July, widened further to -49.1 basis points.


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