US 2-year yield surges 13bps to 4.17% as rate-cut bets evaporate

The US 2-year Treasury yield surged 13 basis points to 4.17%, the highest level in weeks, as traders abandoned bets on near-term Federal Reserve rate cuts.

The selloff in short-dated government debt accelerated after the Personal Consumption Expenditures price index rose 3.8% in April, the largest gain since May 2023, extinguishing hopes the Fed could begin easing by September.

"If you get a hot employment report alongside still-rising inflation numbers, it continues to change the outlook for Fed policy," said Liz Ann Sonders, chief investment strategist at the Schwab Center for Financial Research.

The 10-year yield climbed above 4.53%, while the 30-year bond briefly touched 5.2% before the Memorial Day weekend — a level not seen in 19 years, according to data compiled by Bloomberg. The moves steepened the yield curve as longer-dated bonds underperformed, reflecting concerns about persistent inflation and widening fiscal deficits.

The surge in borrowing costs threatens to add hundreds of billions to federal interest expense, which already runs at nearly $1 trillion annually — exceeding Medicare spending and equaling two-thirds of Social Security outlays. The Committee for a Responsible Federal Budget estimates that if yields persist at current levels, interest costs could consume 30% of all federal revenue by 2036, up from 14% today.

The 2-year note, the most sensitive to Fed policy expectations, has now risen more than 50 basis points from its April low. The repricing has been driven by a string of economic data pointing to sticky inflation and a labor market that shows little sign of cooling. The Fed has held its benchmark rate at 5.25% to 5.50% since July 2023, following a cumulative 525 basis points of tightening that began in March 2022.

May's payrolls report, due June 5, is expected to show the unemployment rate held at 4.3% and nonfarm payrolls increased by 85,000, according to a Reuters poll. An increase of more than 150,000 jobs could fuel fears of an overheating economy and push yields even higher, said Angelo Kourkafas, senior global investment strategist at Edward Jones. The last time the 2-year yield traded above 4.17% was in early May, when a stronger-than-expected jobs report for April triggered a similar selloff.

Fiscal Math Turns Dire

The US will need to borrow almost $10 trillion over the next 12 months, including $7.5 trillion to refinance maturing debt and $2 trillion to cover the budget shortfall, according to the Committee for a Responsible Federal Budget. Much of the existing debt was issued at ultra-low yields during the pandemic era, when Treasury bills offered as little as 0.2%. Today, that cost has jumped to 3.7%.

The average rate on Treasury notes running 5 to 30 years stands at just 3.23%, reflecting years of cheap borrowing. But as the US refinances bonds that roll off at current market rates — 5.2% on the 30-year and 4.7% on the 10-year — the interest burden will compound rapidly. By 2036, interest expense per household would soar from $7,900 last year to $17,000 a decade hence, the CRFB estimates. The CBO had forecast 10-year yields averaging 4.15% through FY2036, roughly 55 basis points below the recent peak — a gap that, if sustained, would add trillions in extra borrowing costs.

The yield surge has also weighed on equity markets, with the S&P 500 coming under pressure as higher discount rates reduce the present value of future earnings. The dollar index strengthened alongside the yield move, with the DXY pushing higher as the rate differential between US and other developed-market bonds widened.

The Federal Reserve's next policy decision is scheduled for June 17-18. Markets now price a less than 50% probability of a rate cut before September, according to CME FedWatch data. New Fed Chair Kevin Warsh has publicly favored tightening monetary policy by reducing the Fed's holdings of Treasuries, a move that could further pressure yields by increasing the supply of government bonds available to the public.

This article is for informational purposes only and does not constitute investment advice.