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Bond Report: 2-year Treasury yields falls to lowest since July on optimism over Fed rate cuts

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Treasury yields dropped further on Wednesday as traders increased bets that the Federal Reserve is likely to start cutting interest rates next year.

What happened

The yield on the 2-year Treasury
BX:TMUBMUSD02Y
fell 8.9 basis points to 4.645% from 4.734% on Tuesday. Yields move in the opposite direction to prices. Wednesday’s level is the lowest since July 13, based on 3 p.m. Eastern time figures from Dow Jones Market Data.

The yield on the 10-year Treasury
BX:TMUBMUSD10Y
retreated 6.5 basis points to 4.270% from 4.335% Tuesday afternoon.

The yield on the 30-year Treasury
BX:TMUBMUSD30Y
dropped 7.2 basis points to 4.450% from 4.522% late Tuesday.

Wednesday’s levels were respectively the lowest for the 10- and 30-year rates since Sept. 13 and 20.

What drove markets

Yields extended the sharp declines seen in recent weeks, with traders expecting that easing inflation pressures will prompt the Fed to consider cutting interest rates next year.

The main catalyst for the latest leg lower in yields appeared to be Tuesday’s comments from Fed Gov. Chris Waller, who said he is increasingly confident that policy is “well positioned to slow the economy and get inflation back to 2%”. Waller is regarded as one of the Fed’s more hawkish officials.

Markets are pricing in a 95.8% probability that the Fed will leave interest rates unchanged at between 5.25%-5.5% on Dec. 13, and a 92% chance of no action by January, according to the CME FedWatch Tool. The chance of at least a 25-basis-point rate cut by May is seen at 78.1%, up from 65.2% a day ago.

On Wednesday, Atlanta Fed President Raphael Bostic, said he’s more confident in his forecast of a soft landing for the U.S. economy. However, his colleague, Richmond Fed President Tom Barkin, said he isn’t ready to say whether the central bank is done lifting rates.

In U.S. economic updates on Wednesday, revised data showed the economy grew at a 5.2% annual pace in the third quarter — faster than previously reported — although the strong gain appeared to be a one-off. Meanwhile, the Fed’s Beige Book of economic anecdotes showed that the economy slowed in November.

In Europe, German 10-year bund yields
BX:TMBMKDE-10Y
fell 6.1 basis points to below 2.44% after data showed inflation fell more than expected in November.

What analysts are saying

“The numbers over the past several weeks have suggested the economy is slowing. Today’s upward revision to an already strong Q3 GDP reading flies in the face of that cooling trend. While one data point is unlikely to push the Fed to raise rates again, it also won’t push them any closer to declaring victory on inflation and cutting interest rates,” said Chris Larkin, managing director of trading and investing at E-Trade from Morgan Stanley.

In One Chart: Favoring 5% savings accounts and CDs over stocks now? Think again.

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