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US bond yields jump to two-year highs as market prices in four Fed hikes in 2022

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19 January 2022

Written by
Matthew Ryan

Head of Market Strategy at Ebury Providing expert currency analysis so small and mid-sized businesses can effectively navigate international markets.

Most currencies lost ground against the resurgent dollar on Tuesday, with a sharp move higher in US yields providing solid incentive for investors to unwind last week’s bearish greenback bets.

A
s investors continue to crank up expectations that the Federal Reserve will raises interest rates at a very aggressive pace in 2022, US Treasuries have sold-off, sending yields sharply higher across the curve. The yield on the benchmark 10-year Treasury note jumped to 1.84% at the close of London trading yesterday, its highest level in two years and an advance of around 12 basis points in just one trading session. While currency traders have largely overlooked the move higher in rates so far this year, and sold the US dollar against most major and emerging market currencies, the extent of the increase in yields on Tuesday was impossible for market participants to ignore. EUR/USD, for instance, ended trading just above the 1.13 mark, a one-week low and back around the levels it held throughout much of December.

The reason for the sharp increase in bond yields is the market’s growing expectation that the Federal Reserve will raise interest rates for the first time in the pandemic era in March, and follow this up with multiple hikes during the remainder of 2022. According to fed fund futures, markets are now fully pricing in a rate increase at the bank’s March meeting and, for the first time, a total of 100 basis points of hikes (or four 25 basis point moves) over the course of the year. The FOMC is set to meet next Wednesday (26th January). While it is too soon for the Fed to raise rates just yet, we now see a very good chance that policymakers will indicate a hike is on the way when the QE programme draws to a close in two months time.

Figure 1: Number of Fed Interest Rate Hikes Priced In for 2022 (18/01/2022)

Source: Refinitiv Datastream Date: 18/01/2022

Elsewhere in markets, the Bank of Japan followed in the footsteps of many of its major peers during its policy meeting on Tuesday, upgrading its view on inflation for the first time since 2014. While the BoJ made no change to its policy, and remains highly unlikely to start raising interest rates any time soon, it now views risks to price growth as ‘generally balanced’, having previously viewed it as ‘skewed to the downside’. The announcement was widely expected and there was little reaction in the yen in response, perhaps partly given the market’s ongoing view that the bank will keep rates unchanged for the foreseeable future.

 

In Europe, the monthly ZEW economic sentiment data for the Euro Area for January surprised to the upside. The economic sentiment index jumped to 49.4 this month from December’s 26.8, well above the 26.4 expected and its highest level in six months (Figure 2). The data provided little assistance to the euro, which was down around three-quarters of a percent on Tuesday. It does, however, at least suggest that European businesses are far less concerned that omicron could weigh on activity in Q1, and that can only be seen as a positive for the common currency.


Figure 2: Euro Area ZEW Economic Sentiment Index (2017 – 2022)

Source: Refinitiv Datastream Date: 18/01/2022

Meanwhile, UK labour data came in almost bang in line with expectations. Earnings including bonuses continue to grow at a solid pace in excess of 4%, with the jobless rate ticking down to 4.1% in November. This morning’s UK inflation data is expected to show price growth increased again in December (5.2% consensus versus November’s 5.1%). This would further fuel the argument that the Bank of England looks likely to be one of the most active central banks in the G10 this year and, as a consequence, we continue to see gains in the pound as likely in the coming weeks.

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