Treasury yields climb as investors anticipate a better market in 2023

U.S. Treasury yields rose Friday, Dec. 30, as investors anticipated potential developments and headwinds in 2023. The benchmark 10-year Treasury yield rose nearly 2 basis points to 3.8520% in early trading. In addition, the 2-year Treasury yield climbed more than 3 basis points to 4.4009% as of 5 a.m. Eastern time.

Treasury yields previously expected to climb as 2023 approaches

Exactly one week ago, reports also suggested that Treasury yields could rise before 2023. At the time, the 10-year Treasury yield was up one basis point to 3.6856%, with the 2-year yield unchanged.

As 2020 draws to a close, talk of an impending recession continues to weigh heavily on investor sentiment. In addition, analysts and observers are also constantly watching the Federal Reserve’s actions on inflation policy. The central bank has raised interest rates by 75 basis points four times in a row this year, but has recently indicated that it will cut rates.

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According to the Federal Reserve, the reduction in interest rate hikes is necessary to avoid an unintended recession. In addition, key consumer price index (CPI) data suggest that inflationary pressures have passed and are diminishing.

Consensus suggests that interest rate hikes may be easing

In November, the Federal Open Market Committee (FOMC) released the minutes of its fiscal meeting, suggesting a slowdown in hikes. The document read in part as follows:

“A number of participants observed that as monetary policy approached a sufficiently restrictive stance to achieve the Committee’s objectives, it would become appropriate to slow the pace of increase in the target range for the federal funds rate.”

However, earlier this month, Fed Chairman Jerome Powell again called for caution, explaining that the economy was not yet out of the woods. In Powell’s view, even if the CPI looked positive, the Fed still had a role to play in curbing runaway inflation. As the Fed president put it:

“The inflation data received so far for October and November show a welcome reduction in the monthly pace of price increases. But much more evidence is needed to be certain that inflation is on a sustained downward path.”

As it stands, the Fed is expected to raise interest rates by 50 basis points heading into the new year. However, the U.S. central bank has also previously suggested that it would keep interest rates higher throughout the next year. According to FOMC members, there would likely be no reduction until 2024.

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Investors ready to rally on any indication of lower inflation

Despite the Fed’s skepticism about inflation, investors and analysts have welcomed talk of tapering rate hikes. This is because any sign of gradual hikes reinforces investors’ belief that inflation may be receding. The Chicago Purchasing Managers’ Index, expected on Friday, is also expected to capture investors’ attention. The index reflects business activity in the region and could also provide additional information for 2023.

Bond markets are scheduled to close early today and will not reopen until after the New Year vacation.

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