A pullback in technology stocks spurred safe-haven buying, while declining oil prices weakened expectations for further interest rate hikes, leading to a rise in US Treasury bonds on Tuesday. A widespread decline in the global semiconductor sector that day sparked investor concerns about the sustainability of the recent sharp rally in artificial intelligence (AI)-related stocks. The cooling risk appetite drove capital towards safe-haven assets like US Treasuries and the US dollar.
Concurrently, the continued fall in international oil prices also alleviated market worries about inflationary pressures, thereby reducing the perceived necessity for the Federal Reserve to implement further rate increases. Data from the interest rate swaps market indicated that investors' bets on Fed rate hikes over the next year have slightly receded. The market currently expects a cumulative rate hike of approximately 45 basis points by mid-2027, lower than previous estimates.
RBC Capital Markets interest rate strategist Izaac Brook noted that the market has largely priced in expectations for a more hawkish Federal Reserve policy. "Current pricing already reflects a more hawkish Fed outlook," he stated. He pointed out that the inflation-adjusted real yield on the US 2-year Treasury has climbed to its highest level since the Fed began its rate-cutting cycle in September 2024, signaling a significant shift in market expectations for the future path of interest rates.
Driven by buying interest, US Treasury prices rose, with yields across maturities broadly falling by about 1 to 3 basis points. Short-dated bonds, which are most sensitive to monetary policy changes, performed the best. By the close in New York, the yield on the 2-year Treasury note fell roughly 3 basis points to 4.20%; the 10-year Treasury yield also edged lower.
Notably, the US Treasury's auction of $69 billion in 2-year notes that day saw robust demand, further supporting the bond market. The auction's final high yield was 4.189%, below market expectations, which is typically seen as a signal of strong demand. However, this yield remains the highest for a 2-year note auction since January 2025.
This auction occurred less than a week after Federal Reserve Chair Kevin Warsh's first post-meeting press conference. At last week's meeting, Warsh conveyed a relatively hawkish stance and emphasized that controlling inflation remains the Fed's top priority. Subsequently, the market quickly raised expectations for future rate hikes, causing the 2-year Treasury yield to surge significantly at one point.
Wells Fargo interest rate strategist Angelo Manolatos suggested that with the market already pricing in nearly 50 basis points of rate hikes over the next year, the current yield levels on 2-year notes are beginning to appear attractive to some investors. "In a scenario where close to 50 basis points of hikes over the next year are already priced in, investors might see value in the current 2-year Treasury," Manolatos said.
This week, the US Treasury will continue with its fixed-rate note issuance. Following the 2-year notes, auctions for 5-year and 7-year notes are scheduled over the next two days.
It is worth noting that earlier in the week, yields on 5-year and 10-year US Treasuries had risen to at least one-week highs, even as international oil prices had already begun to retreat. Some traders believe this unusual move might be related to the recent large-scale bond financing initiated by SpaceX. It is reported that SpaceX recently launched a bond financing plan amounting to as much as $25 billion. Market participants suggest that some investors may have engaged in early interest rate hedging operations, which could have temporarily exerted upward pressure on medium- to long-term US Treasury yields.
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