Benchmark 10-year U.S. Treasury yields rose in choppy trading on Wednesday after data showed that the U.S. economy contracted for the first time in three years in the first quarter while inflation also rose, complicating the outlook for the Federal Reserve. The advance gross domestic product (GDP) report reflected a flood of imports as businesses raced to avoid higher costs from tariffs and underscored the disruptive nature of President Donald Trump's often-chaotic trade policy. GDP decreased at a 0.3% annualized rate last quarter, much weaker than the 0.3% growth rate forecast by economists polled by Reuters, and the 2.4% growth from the October-December period.
The GDP deflator, a proxy for inflation, was 3.7%, higher than the prior quarter's 2.3% and the expected 3.0%. "I would not describe what's happening now as stagflation. The situation is very different from what happened in the U.S. in the late 1970s and 1980s.
However, price pressures are present and growth is clearly slowing," said Guy LeBas, chief fixed income strategist at Janney Montgomery Scott. "It's very hard to know what the Fed will do ahead." In the first quarter, the Personal Consumption Expenditures Price Index rose 3.6% compared with a 2.4% rise in the fourth quarter of last year, the GDP data showed.
The core reading, excluding food and energy, rose 3.5% after a 2.6% rise. Separate data showed the PCE index, tracked by the Federal Reserve for its 2% inflation target, was up 2.3% in March. Earlier, yields ticked lower after the release of the ADP National Employment report showing 62,000 new private sector jobs in April, fewer than the previous month's downwardly revised 147,000.
ADP and Tuesday's Job Openings and Labor Turnover Survey (JOLTS) serve as runway indicators to Friday's April payrolls report, likely to be the biggest news event of the week. "The labor market data is really key as we go forward from here. … Any meaningful slowdown in hiring or job separations is going to lead to a deterioration in consumption," said Charlie Ripley, senior investment strategist at Allianz Investment Management.
Traders slightly pared back bets that the Fed will cut rates in June on Wednesday, with the odds of a cut that month now at 66.6%, according to the CME Group's FedWatch Tool. Meanwhile the Treasury Department said on Wednesday it expects to keep its coupon and floating-rate note auction sizes steady for at least the next several quarters and will study potential changes to its buyback program to support market liquidity. While largely as expected, the Treasury statement was seen as disappointing by some investors who were looking for an increase in buybacks and/or a discussion over potentially shortening the average weighted maturity on Treasuries to help support longer-dated debt.
The yield on the benchmark U.S. 10-year Treasury note (US10YT=TWEB) was last up 0.7 basis points on the day at 4.181%. It is on track for a monthly decline of only 7 basis points despite a volatile month that sent yields as low as 3.860% and as high as 4.592% during the "tariff tantrum" that followed Trump's April 2 announcement of higher-than-expected tariffs. The yield on the 30-year bond (US30YT=TWEB) rose 3.5 basis points to 4.683%.
A closely watched part of the U.S. Treasury yield curve measuring the gap between yields on two- and 10-year Treasury notes (US2US10=TWEB), seen as an indicator of economic expectations, was at 56 basis points, around 4 basis points steeper on the day. It has steepened 20 basis points this month, the largest increase since December. The two-year (US2YT=TWEB) U.S. Treasury yield, which typically moves in step with interest rate expectations, fell 3.5 basis points to 3.623%.
It is on pace for a monthly decline of 29 basis points, the largest monthly drop since August. The breakeven rate on five-year U.S. Treasury Inflation-Protected Securities (TIPS) (US5YTIP=TWEB) was last at 2.301% after closing at 2.292%. The 10-year TIPS breakeven rate (US10YTIP=TWEB) was last at 2.233%, indicating the market sees inflation averaging about 2.3% a year for the next decade.
