U.S. two-year yield at almost 15-year high before Fed meeting

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By Herbert Lash

NEW YORK (Reuters) - The yield on two-year U.S. Treasury notes, a rough gauge of interest rate expectations, rose to almost a 15-year high on Tuesday, a day before the Federal Reserve is likely to hike rates by another 75 basis points to curb surging inflation.

The two-year is highly sensitive to shifts in monetary policy expectations and early on Tuesday it hit 3.992%. The last time its yield broke above 4% was Oct. 18, 2007.

The Fed is scheduled to announce its latest policy decision on Wednesday. Money markets are fully pricing in a 75 basis point rate hike, with just an 18% chance of a larger full-point rate rise, according to CME's FedWatch tool.

Sweden's central bank earlier raised interest rates by a larger-than-expected full percentage point to 1.75% and warned of more to come as it also seeks to tame inflation.

Yields on the benchmark 10-year Treasury shot up 11.1 basis points to 3.600%, having only topped 3.5% for the first time in 11 years on Monday. The two-year yield rose 4 basis points to 3.986%.

The 10-year moving higher and faster than the two-year could just be positioning in front of tomorrow’s Fed statement or it could be the Riksbank raising rates more than expected, said Lawrence Gillum, fixed income strategist at LPL Financial (NASDAQ:LPLA).

"What’s happening for the Fed and other central banks is there’s a push to front-load these rate hikes," Gillum said.

"There's a lot of jitters and some pre-positioning that’s going into tomorrow’s meeting," he said. "Foreign rates moving higher, that makes our rates less attractive."

The closely watched gap between two- and 10-year yields earlier reached a discount of as much as -47.5 basis points, approaching its most negative since Aug. 10 when the discount widened to -56.2 basis points. The gap later narrowed to -39.0 basis points.

The two- and 10-year yield inversion, when the short end is higher than the long end, often has been seen as a reliable predictor of a recession in a year or two.

After the Fed statement on Wednesday the market will try to gauge whether the U.S. central bank will raise rates by 50 basis points in November, said Anthony Saglimbene, chief market strategist at Ameriprise Financial (NYSE:AMP) in Troy, Michigan.

"I don't think they're going to communicate that, but I think the market will try to anticipate that and if they do, then you could see over the coming months some equilibrium level in rates," Saglimbene said.

"The terminal rate at which the Fed will stop raising interest rates is higher, and that terminal rate is likely to last longer," he said. "All of it is centered around inflation pressures that are more persistent."

The yield on the 30-year Treasury bond was up 10.7 basis points to 3.612%.

The breakeven rate on five-year U.S. Treasury Inflation-Protected Securities (TIPS) was last at 2.534%.

The 10-year TIPS breakeven rate was last at 2.396%, indicating the market sees inflation averaging about 2.4% a year for the next decade.

The U.S. dollar 5 years forward inflation-linked swap, seen by some as a better gauge of inflation expectations due to possible distortions caused by the Fed's quantitative easing, was last at 2.405%.

Sept. 20 Tuesday 10:50 AM New York / 1450 GMT

Price Current Net

Yield % Change

(bps)

Three-month bills 3.29 3.364 0.062

Six-month bills 3.7925 3.9205 0.043

Two-year note 98-163/256 3.9856 0.040

Three-year note 98-188/256 3.9537 0.054

Five-year note 97-28/256 3.7713 0.078

Seven-year note 96-104/256 3.7169 0.100

10-year note 92-252/256 3.5984 0.109

20-year bond 93-44/256 3.87 0.097

30-year bond 88-228/256 3.6104 0.105

DOLLAR SWAP SPREADS

Last (bps) Net

Change

(bps)

U.S. 2-year dollar swap 37.00 0.25

spread

U.S. 3-year dollar swap 17.00 -0.25

spread

U.S. 5-year dollar swap 8.50 0.25

spread

U.S. 10-year dollar swap 6.25 -0.50

spread

U.S. 30-year dollar swap -30.75 -1.25

spread