With the Federal Reserve tightening monetary policy, the two-year U.S. Treasury yield has risen to its highest level since mid-2019. The current yield is at the top of the six-month trading range of 0.27%-2.36%. The two-year With the Federal Reserve tightening monetary policy, the two-year U.S. Treasury yield has risen to its highest level since mid-2019. The current yield is at the top of the six-month trading range of 0.27%-2.36%. The two-year yield is up over 200 basis points since last summer, which indicates the market is expecting several more rate hikes by the Fed. If the Fed signals additional rate hikes over the next 12-24 months the yield will likely push higher. The current spread between the two-year and 10-year Treasury yield is less than 5 basis points. In the past, when the two-year yield exceeded the 10-year yield the Treasury curve was said to be inverted, and a recession typically occurred 9-24 months later.yield is up over 200 basis points since last summer, which indicates the market is expecting several more rate hikes by the Fed. If the Fed signals additional rate hikes over the next 12-24 months the yield will likely push higher. The current spread between the two-year and 10-year Treasury yield is less than 5 basis points. In the past, when the two-year yield exceeded the 10-year yield the Treasury curve was said to be inverted, and a recession typically occurred 9-24 months later.

The six-month trading range for the 10-year Treasury yield is 1.38%-2.46%, with expectations it will trend higher as economic reports signal modest economic growth while the Fed tightens policy rates and transitions to quantitative tightening. The inflation and employment outlook are also an indicator of long-term yields. The jump in oil prices is taking a toll on consumers wallets and will likely work to reduce consumer confidence and spending. The top of the 10-year trading range could increase to 2.75% during the second half of the year as it takes time for Fed rate hikes to impact the economy. If signs of a much weaker growth outlook begin to form, longer-term yields could decline, possibly resulting in an inverted yield curve, as discussed above.

The employment report from the Bureau of Labor Statistics comes from two surveys. The establishment survey reports data related to nonfarm payrolls and earnings. The household survey collects employment and labor force data and is the source for calculating the unemployment rate.

Nonfarm Payrolls: February's payrolls of 678,000 surpassed market expectations, according to the establishment survey, versus consensus projections for a gain of 423,000. Seasonal adjustments and measurement challenges continue to be a source of market volatility. Revisions to the prior two months’ reports added 92,000 jobs. Leisure and Hospitality continued to lead gains with strong growth from Professional and Business Services and Education and Health Services. Government jobs rose 24,000 while private sector payrolls increased 654,000. Compared to a year ago, employment is up 4.6%. Hiring difficulties for many businesses continues in 2022 and is exerting upward pressure on wages.

Unemployment Rate: Household employment rose by 548,000 while the labor force increased by 304,000 resulting in a decrease in the number of unemployed of 243,000, which pushed the unemployment rate down 0.2 percentage points to 3.8%. The “under-employment” rate, which includes people who want a job but are not actively looking, increased 0.1 percentage points to 7.2%. It was the first increase since the early stages of the pandemic in April 2020.

Earnings: Average hourly earnings compared to a year ago remain strong. However, inflation is pushing real average hourly earnings lower.

Overall, the report suggests demand for labor remains strong and supports the outlook for continued gradual increases in employment and the likelihood of several rate hikes by the Federal Reserve for this year and next.

Gross Domestic Product: As more information was released, the final estimate of Q4-2021 GDP growth was revised lower on weaker businesses and residential investment (housing). Inventory growth remained a significant contributor to growth for the quarter while moderate consumer spending (personal consumption) will be watched carefully. The impact of high inflation dropped the U.S. nominal growth rate from 14.3% to a real growth rate of 6.9%. On a year-over-year basis, the economy grew by an inflation adjusted rate of 5.5%.

Looking ahead, the strong growth in inventories for Q4-2021 may have pulled forward growth that would have occurred in Q1-2022. The outlook for 2022 is full of uncertainty with the market expecting a 2.5%-3.5% increase in economic activity as the Fed tightens monetary policy and businesses adapt to rising interest rates and inflationary pressure from higher wage costs and geopolitical and pandemic related supply shortages and disruptions. Rising gas prices could hinder consumer confidence and spending in 2022. Fiscal stimulus efforts may impact growth provided Congress is able to agree on a social and climate spending bill.

Consumer Price Index: CPI continued to accelerate in February with overall inflation coming in at 7.9% (from 7.5% last month) while core inflation rose to 6.2% (from 6% last month), levels not seen in over 40 years. February Total CPI rose 0.8% month over month as motor fuel costs rose by 6.7% and lodging away from home increased 2.2%. Food prices rose 1%. Core CPI, which excludes food and energy, rose 0.5% on strong gains in airline fares (+5.2%) and rent of primary residence (+0.6%).

While it’s possible pandemic-related categories may offset some of the acceleration in shelter prices in the coming months, there are few signs of that so far, and core inflation pressures are expected to remain significant throughout the first half of the year. For the past three months the annualized CPI averaged 8.4% while core averaged 6.8%. The figures are very similar for the six-month annualized averages, which are 8.3% and 6.2%, respectively.

With West Texas Intermediate crude oil trading in a range of $90-$124 per barrel since mid-February, look for continued upward pressure on headline inflation. Overall, core inflation pressures remain significant due to persistent supply chain problems and higher housing prices and wage costs, which are now being further complicated by energy market turmoil from the Russian invasion of Ukraine. We may not see year-over-year inflation drop below 4% until 2023, which was previously expected to occur around mid-year.

Following the March 15-16 Federal Open Market Committee meeting, policymakers announced a 25 basis point increase in the target range for the federal funds rate to 0.25-0.5%. Based on comments in the post-meeting statement the market expects increases in policy rates this year. Furthermore, the Committee said it expects to soon begin reducing its holdings of Treasury and agency debt and agency mortgage-backed securities. The next FOMC meeting is May 3-4.

The Open Market Desk at the Federal Reserve Bank of New York is currently operating under a directive to roll over at auction all principal payments from Fed holdings of Treasury securities and reinvest all principal payments from holdings of agency debt and agency MBS. This action keeps past rounds of QE in place.