Treasury Two-Year Notes Fall as Inflation Rises Most Since 2011

  • Core consumer prices advance more than forecast in January
  • Traders boost wagers that the Fed will raise rates this year

Short-dated Treasuries fell after a report showed the cost of living in the U.S. excluding food and fuel increased in January by the most in more than four years, reinforcing the Federal Reserve’s message that inflation will rise toward its 2 percent target.

Yields on two-year notes, the maturity most sensitive to Fed policy expectations, climbed as the Labor Department’s consumer price index reading prompted traders to boost bets that the central bank will raise rates this year. Fed funds futures indicate about one expected increase this year, versus the four that policy makers forecast in December when they lifted rates for the first time in almost a decade.

"The CPI being better than expected has pushed back against people who were moving the timing of Fed hikes out this year," said Larry Milstein, managing director of government-debt trading at R.W. Pressprich & Co. in New York. "You get a reversal in the front end" of the Treasury yield curve, he said.

Tumbling oil prices and stock-market losses have prompted traders this year to cut their five-year inflation expectations beginning five years from now, a model the Fed uses in setting policy, to record-low levels and reduce bets the central bank will raise rates in 2016. Fed Chair Janet Yellen has said officials expect price gains to gradually climb as a strong dollar and low oil prices dissipate.

The U.S. two-year note yield rose five basis points, or 0.05 percentage point, to 0.74 percent as of 5 p.m. in New York, according to Bloomberg Bond Trader prices. The yield rose three basis points on the week. The price of the 0.75 percent note due January 2018 fell 3/32, or 94 cents per $1,000 face amount, to 100.

Benchmark 10-year note yields were little changed at 1.74 percent.

The core consumer-price measure climbed 0.3 percent last month, more than forecast and the most since August 2011, after a 0.2 percent gain the month before, the Labor Department report showed Friday in Washington. The core index advanced 2.2 percent from a year earlier, the most since June 2012.

If inflation continues to rise at this pace, "we’re looking at a really big divergence on what the market is telling us and what the inflation data are telling us," said Guy LeBas, chief fixed-income strategist at Janney Montgomery Scott LLC in Philadelphia.

Futures traders see a 43 percent probability the Fed will lift its target this year, up from a 37 percent chance assigned Thursday. At the beginning of the year that assigned probability was 93 percent. The calculation is based on the assumption that the effective fed funds rate will trade at the middle of the new target range after the next increase.

Before it's here, it's on the Bloomberg Terminal.