US government bonds under further pressure after upbeat economic data

Strong corporate earnings and positive economic data helped underpin solid gains for US stocks, but government bonds continued to slide in the wake of remarks from central bankers earlier in the week reinforcing their pledge to fight inflation.

Wall Street’s benchmark S&P 500 index was up 1.7 per cent in mid-afternoon trading on Wednesday, with tech and consumer stocks leading the way. That helped recoup declines from the first two days of this week.

PayPal, after markets closed on Tuesday, became the latest large tech group to report better than expected second-quarter earnings and also announced that activist investor Elliott Investment Management had amassed a $2bn stake in the company.

Shares in PayPal jumped 9.5 per cent, leading a broader rally in the sector that lifted the Nasdaq Composite 2.7 per cent to a three-month high.

Investor sentiment was also helped by strong results from a closely watched survey of the US services sector. The Institute for Supply Management’s purchasing managers’ index suggested the sector expanded in July more quickly than the previous month, confounding expectations of a slowdown. The report was more upbeat than a similar survey of factory executives released earlier this week.

“Recent [ISM services] results, while below the red-hot tallies of the autumn and early winter, are nonetheless still quite solid on an historical basis, and the July increase appears at odds with predictions that the economy is either in recession now or very close to slipping into one,” said Joshua Shapiro, chief US economist at consultancy MFR.

Government bond markets, in contrast, sustained further selling as investors shifted their expectations of how aggressively the Federal Reserve would raise interest rates to fight inflation.

The yield on the two-year Treasury note, which is particularly sensitive to short-term policy expectations, rose a further 0.03 percentage points to 3.11 per cent. Yields rise when prices fall, and the two-year yield has jumped more than 0.2 percentage points over the past two days.

Moves of this magnitude are unusual in the $23tn US government bond market and highlight the scale of the uncertainty over the direction of monetary policy. They also come during the summer holiday season, a time when thin trading volumes often exacerbate volatility across financial markets.

The yield on the benchmark 10-year note rose 0.01 percentage points, to 2.75 per cent.

Yields tumbled last week after the Fed hinted that the pace of interest rate increases could moderate after it announced it would raise benchmark borrowing costs by 0.75 percentage points for the second month in a row.

Line chart of Two-year Treasury yield (%) showing US short-term government bond yields jump

However, San Francisco Fed president Mary Daly said in an interview on Tuesday that the central bank was “nowhere near” done with its fight to cool inflation, which continues to run at 40-year highs.

In a separate interview, Chicago Fed president Charles Evans said a half- percentage point Fed rate rise in September was likely, but a 0.75 percentage point rise “could also be OK”.

Richmond Fed president Thomas Barkin repeated the message on Wednesday, emphasising that the Fed “will do what it takes” to bring inflation back to its 2 per cent target.

Line chart of Implied federal funds rate for February 2023 (%) showing Fed rate rise expectations back on the ascent


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