(Bloomberg) --The year-to-date selloff in Treasuries worsened after minutes from the Federal Reserve’s latest meeting showed officials considering earlier and faster interest-rate increases than previously expected.
Yields on 10-year Treasuries rose to as high as 1.7087%, a level last seen in April, and overnight swaps markets moved to price in an 80% chance of a 25 basis point hike at the Fed’s meeting in March. Yields on two-year notes reached 0.8316%, the highest since March 2020.
Federal Open Market Committee members also discussed starting to shrink the central bank’s swollen balance sheet soon after their first hike, the minutes showed.
“These minutes are very hawkish, and it shows an FOMC that wants to lean against the market big time,” said George Goncalves, head of U.S. Macro strategy at MUFG. “The bond market still views policy tightening being primarily conducted through the front end,” which may mean that short-dated yields will lead the way higher until plans for shrinking the balance sheet come into focus, he said.
Ahead of the minutes, bond investors were anticipating possible guidance as to whether the Fed is prepared to start raising rates in March, accelerate the pace of asset-purchase tapering, or begin shrinking its balance sheet.
The December meeting produced the decision to conclude their monthly bond purchases by March, paving the way for raising its overnight benchmark rate, and revealed that on average, policy makers expect to raise rates three times this year.
While interest-rate futures conform to that forecast, the market had continued to price in less policy tightening overall than Fed policy makers, who on average expect a long-run fed funds target of 2.5%.
Fed Governor Christopher Waller last month said that an early start to shrinking the balance sheet means “you don’t have to raise rates quite as much.”
The Fed’s balance sheet doubled in size to more than $8 trillion starting in March 2020, when the central bank begun buying Treasury and mortgage-backed securities, first to stabilize the market and then to provide additional support to the economy with the policy rate at 0%.
Long-dated Treasury yields remain low by historical standards, and therefore remain stimulative for households and companies.
“It needs to be clear to watchers of the Fed that it’s a matter of when, not if, balance sheet reduction takes place,” Bob Miller, BlackRock Inc.’s head of Americas fundamental fixed income, wrote after the release.
(Adds strategist comment in fourth paragraph, detail throughout. A previous version of this story corrected the level reached by 10-year yields.)
--With assistance from Michael MacKenzie and Edward Bolingbroke.
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