U.S. yields rise on higher headline inflation, consumer sentiment

U.S. Treasury yield gained on Friday after data showed U.S. monthly producer prices came in higher than expected for November and consumer sentiment improved, suggesting interest rates will remain higher for longer.

However, the year-on-year rate for underlying producer prices, which exclude food and energy, has declined, data showed, giving the Federal Reserve ample room to slow its tightening pace, as Chair Jerome Powell indicated on November 30.

"Inflation is definitely trending down and it's going to come down more," said Brian Reynolds chief market strategist, at Reynolds Strategy, adding that Treasury yields rose as a knee-jerk reaction.

Data showed that the U.S. producer price index for final demand rose 0.3% last month, with the October figure revised higher to show PPI gaining 0.3% instead of 0.2% as previously reported. Economists polled by Reuters had forecast PPI climbing 0.2% last month.

Excluding food and energy, producer prices rose 6.2% year-on-year, higher than forecast as well but lower than the previous month's number of 6.8%.

"Easing producer prices foreshadow an improving inflation environment. The Fed will likely downshift the pace of rate hikes next week and should continue to downshift in 2023," wrote Jeffrey Roach, chief economist for LPL Financial, in North Carolina, in an email.

"However, the monthly increase in producer prices illustrates the need for continued tightening, albeit at a slower pace. The inflation pipeline is clearing and consumer prices will slowly move closer to the Fed's long run target," he added.

U.S. yields also gained after data showed consumer sentiment rose in December while inflation expectations eased to a 15-month low.

The University of Michigan's preliminary December reading on the overall index of consumer sentiment came in at 59.1, up from 56.8 in the prior month. The survey's reading of one-year inflation expectations fell to 4.6%, the lowest reading in 15 months, from 4.9% in November.

In afternoon trading, the yield on 10-year Treasury notes US10Y rose 9.1 basis points (bps) to 3.583%.

U.S. 30-year yields (US30YT=RR) were up 12.2 bps at 3.575%.

A closely-monitored part of the U.S. Treasury curve measuring the spread between yields on two- and 10-year Treasury notes (US2US10=RR) narrowed its inversion to -75.6 bps on Friday. The curve inverted to as much as -85.2 bps on Wednesday, the most in two weeks.

This curve's inversion typically foreshadows recession.

On the shorter-end of the curve, the two-year (US2YT=RR) U.S. Treasury yield, which typically moves in step with interest rate expectations, gained 2.2 bps to 4.333%.

Reynolds of Reynolds Strategy, in support of the downtrend in inflation, cited the declining trend in breakeven inflation rates for U.S. Treasury Inflation-Protected Securities (TIPS), a "good leading indicator" for the rise in future prices.

On Friday, the U.S. two-year breakeven rate fell to 2.345% (USBEI2Y=RR) from 2.407% late on Thursday, suggesting that investors expect inflation to average around 2.34% over the next two years. Since early November, the two-year breakeven inflation rate has fallen by about 57 bps.

The breakeven rate on five-year TIPS (USBEI5Y=RR) was last at 2.370%, down from Thursday's 2.411%.

The 10-year TIPS breakeven rate (US10YTIP=RR) also fell, down at 2.285%, from 2.307% late on Thursday.

The Fed is widely expected to raise interest rates by 50 bps at next week's policy meeting.

December 9 Friday 4:03PM New York / 2103 GMT