December 5, 2017 / 3:55 PM / a year ago

TREASURIES-Short-term yields hit multi-year highs, yield curve flattens on Fed bets

* U.S. 2-year yields hit highest since 2008

* 3-year yields hit highest since 2009

* 5-30-year yield curve flattest since 2007

By Dion Rabouin

NEW YORK, Dec 5 (Reuters) - Short-dated U.S. Treasury yields rose to their highest in more than eight years on Tuesday as investors’ expectations grew for the U.S. Congress to pass tax reform legislation and for the Federal Reserve to raise interest rates several times next year.

The yield on the 2-year note touched its highest level since October 2008 and the 3-year note yield hit its highest since June 2009.

The yield curve flattened, with the difference between the yield on five- and 30-year debt hitting its lowest in a decade.

Fed funds futures prices show that investors see a rate hike at the U.S. central bank’s Dec. 12-13 meeting as a certainty and odds of bringing the U.S. overnight interest rate to a range of 1.50-1.75 percent, a 50-basis-point hike, having risen to nearly 10 percent. Futures prices show a zero percent chance of rates remaining at their current level of 1.00-1.25 percent.

Fed policymakers have said for much of this year that they expect to raise rates three to four times next year. However investors have been slow to price in those predictions and long-term inflation expectations have remained subdued. Analysts said Tuesday’s price action was partially a function of the market beginning to buy into the Fed’s prognostications.

“Fed fund futures and euro dollar (investors) did not believe the Fed even though they said three to four hikes,” said Evercore ISI strategist Stan Shipley. “I think they’re looking at the current data, tax reform and oil prices and thinking, ‘Oh the Fed may have it right.’”

The 2-year Treasury note, the most sensitive to Fed policy expectations, rose to 1.835 percent. The three-year note touched 1.95 percent.

The spread between yields on the 5-year Treasury note and 30-year bond dropped to 59.6 basis points, the lowest since October 2007.

Investors are pricing in multiple rate hikes from the Fed in response to strong U.S. employment data and a pickup in inflation, but see limited upside for long-term inflation, even with passage of the proposed tax bill.

Evercore’s Shipley said investors also are undervaluing the possibility of a U.S. government shutdown if lawmakers cannot reach an accord this week. Government funding is set to expire Friday.

“Talking to international clients they are completely oblivious to this,” he said. “Issues on tax reform and Trump have captured their attention and they’re not thinking about what a shutdown could do.” (Reporting by Dion Rabouin; Editing by Andrea Ricci)

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