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Bond Report: Two-year Treasury yield sees biggest drop in almost three weeks on omicron concerns, doubts about Fed projection for higher interest rates

The two-year Treasury rate saw its biggest drop in almost three weeks on Thursday as investors focused on the impact of the omicron variant and questioned whether the U.S. can handle higher interest rates projected by the Federal Reserve.

What are yields doing?

The 2-year Treasury yield TMUBMUSD02Y, 0.608% declined 6.4 basis points to 0.619%, compared with 0.683% late Wednesday. That’s the largest one-day decline since Nov. 26, based on 3 p.m. levels, according to Dow Jones Market Data. It’s also the yield’s lowest level since Dec. 3.
The yield on the 10-year Treasury note BX:TMUBMUSD10Y fell 3.8 basis points to 1.422% from 1.46% at 3 p.m. Eastern on Wednesday. That is the lowest level for the yield since Dec. 3.
The yield on the 30-year Treasury bond TMUBMUSD30Y, 1.861% rose less than 1 basis point to 1.860%, up from 1.851%.

What’s driving the market?

Investors flocked to the safety of Treasurys on Thursday, pushing down most yields as concerns about the omicron variant flared and doubts lingered that the Federal Reserve will be able to push interest rates aggressively higher to help combat inflation.

The rally led to lower yields on everything from 1-month bills to the 10-year Treasury bond. Yields on 2-year to 7-year maturities, which capture the period in which the Federal Reserve plans to execute its next rate-hike campaign, bore the brunt of the declines.

A multitude of factors were weighing on investors in the bond market Thursday, including the view that the U.S. and/or global economy may be heading for a slowdown. One of the biggest potential reasons is the omicron variant of COVID-19, which has led to canceled holiday parties, the abrupt end of in-person activities at a number of colleges, and delayed return-to-office dates at companies like Apple Inc.

Read: Here’s why concerns about omicron and doubts in the Fed’s ability to deliver aggressive rate hikes are pulling down Treasury yields

The bond-market moves were somewhat counterintuitive, considering the Federal Reserve’s hawkish turn was expected to drive Treasury yields sustainably higher, at some point.

On Wednesday, in their final policy update of 2021, policy makers decided to more quickly wind down, or taper, monthly asset purchases — putting the central bank on track to end around March. The latest so-called dot plot, tracking individual policy makers’ rate expectations, also showed expectations for rates to rise three times in 2022, up since their September forecasts.

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Attention also turned to other central bank decisions on Thursday.

The Bank of England surprised markets, becoming the first major central bank to deliver an interest-rate increase since the pandemic began, by unexpectedly lifting its key benchmark 15 basis points to 0.25%. Bank of England policy makers voted 8 to 1 to raise their key lending rate, despite omicron’s spread and its potential economic impact.

The ECB, meanwhile, affirmed that its supplemental Pandemic Emergency Purchase Program, or PEPP, will end as scheduled in March, but policy makers softened the blow by increasing purchases under a different program.

Read: ECB to end emergency pandemic asset buys in March, while Bank of England delivers ‘Super Thursday’ surprise

In U.S. data releases on Thursday, new applications for jobless claims climbed by 18,000 in mid-December to 206,000, but the increase likely reflected statistical quirks tied to temporary hiring during the holiday shopping season.

Meanwhile, the Federal Reserve Bank of Philadelphia’s gauge of regional business activity fell to 15.4 in December from 39.0 in the previous month. And U.S. home builders started construction on homes at a seasonally-adjusted annual rate of 1.68 million in November, representing a nearly 12% increase from the previous month, as the pace of permitting for new housing units also increased.

Industrial production rose 0.5% in November, the Federal Reserve reported Thursday, continuing a strong trend in output. Capacity utilization rose to 76.8% in November from 76.5% in the prior month. 

IHS Markit’s purchasing manager index flash reading for manufacturing fell to 57.8 in December from 58.3, while the gauge for services activity dropped to 57.5 in December from 58.

What are analysts saying?

“Concerns over Covid seem to be the driving force at the moment,” said Gennadiy Goldberg, a senior U.S. rates strategist for TD Securities. “With festivities canceled and a resurgence of covid, there’s worries this could dent the economic recovery, at least for the near term.”
“Even though Powell is talking tough, the bond market doesn’t believe the economy can get its legs underneath it,” said Michael Franzese, head of fixed-income trading at MCAP, referring to Fed Chairman Jerome Powell. “What the market basically is saying to the Fed is, you won’t be able to raise rates much. And if you did, you would have done it by now.”

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