(Bloomberg) -- Treasuries slid on concern a rally in oil will keep inflation elevated and put pressure on the Federal Reserve to go on raising interest rates.
Shorter maturities led declines as WTI and Brent crude jumped as much as 8% in early trade after the OPEC oil cartel said over the weekend it would reduce production from next month. The dollar strengthened against all its major peers except the currency of oil supplier Norway, reflecting bets on more Fed rate hikes.
OPEC’s desire to halt the decline in oil prices “will simply cause some of the expectations for a slowdown in inflation to be faded away,” said Hidehiro Joke, a senior bond strategist at Mizuho Securities in Tokyo. “Since inflation is likely to remain the biggest driver of the Fed’s monetary policy, the market will be less likely to assume an early shift to lower rates or a faster pace of rate cuts.”
US two-year yields jumped as much as 11 basis points to 4.14%, while the benchmark 10-year yield climbed 7 basis points to 3.54%.
Markets are coming off one of their most turbulent quarters in recent years, with Treasuries generating their best returns since 2020. That leaves them vulnerable to reversals in the event of disruptions to its base case that the Fed is about to end its tightening cycle.
Two-year yields had dropped more than a full percentage point from their highs above 5% last month to as low as 3.55% amid concern over a global banking crisis.
Swaps traders are pricing in about a 63% chance the Fed will raise rates again at its May policy meeting, up from 56% odds on Friday, according to data compiled by Bloomberg. Markets then expect the central bank to cut borrowing costs a half-point by year-end, the data show.
Short-maturity yields were already climbing as fears of a more systemic banking crisis wane and demand for emergency bank liquidity programs stabilizes, said Mahjabeen Zaman, head of currency research at Australia & New Zealand Banking Group Ltd. in Sydney. Still, the US PCE deflator, which is the Fed’s preferred price gauge, and European inflation data are pointing to downward momentum in consumer cost prices, she said.
The Bloomberg Dollar Spot Index pared gains as trading opening in London, while the Norwegian krone outperformed and the Japanese yen slid 0.5%.
Energy stocks were the top performers in Europe, with a gauge of the companies climbing more than 3.5%, while broader equities benchmark underperformed. Futures contracts on the S&P 500 Index dropped 0.1%.
The gains in oil may be temporary as the output cuts are coming against a target that was inflated by over a year of planned monthly increases that never happened, so it may not actually constrain supply, said Ilya Spivak, head of global macro at tastylive, a financial network. “Markets got surprised but I don’t see oil having a lot of upside follow-through and hence the impact on Asian stocks will seemingly be short-lived.”
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