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Strong economic data raises prospect of yields surging

further

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Some fear inflation rebound, see risk of Fed hike

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Higher yields could further wobble stocks

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Some see 5% yield as threshold for allocation shifts

By Davide Barbuscia

NEW YORK, Jan 10 (Reuters) - A recent surge in U.S.

Treasury yields may gain even more momentum after a strong jobs

report reinforced expectations that interest rates will stay

high for longer and raised the spectre of benchmark 10-year

yields hitting 5% - a level that some fear could rattle broader

markets.

Friday's jobs report revealed that employers added 256,000

jobs in December, well above economists' forecasts, while the

unemployment rate dropped, bolstering market expectations that

the Federal Reserve will maintain elevated interest rates to

curb economic overheating.

That news dashed investors' hopes for some respite from a

sharp rise in Treasury yields that has wobbled stocks since the

beginning of the year. The data also re-ignited concerns about

inflation, which remains stubbornly above the Fed's 2% target.

"The report was obviously negative for inflation," said

Felipe Villarroel, partner and portfolio manager at TwentyFour

Asset Management. "This is definitely not an economy that is

decelerating."

Traders are now expecting the central bank will wait until

at least June to reduce its policy rate. Before the jobs data,

they were betting the Fed would cut rates as early as May with

about a 50% chance of a second cut before year end.

Both J.P. Morgan and Goldman Sachs pushed their Fed rate cut

forecast to June, having earlier projected a cut in March.

Concerns over a rebound in inflation have also begun to

raise the prospect that the Fed's next move could be a hike - a

scenario that would have been unthinkable a few months ago when

investors expected interest rates would have declined to about

2.8% by the end of this year. They are now at 4.25%-4.5%.

"Our base case has the Fed on an extended hold. But we think

the risks for the next move are skewed toward a hike," analysts

at BofA Securities said in a note on Friday.

Longer-dated U.S. Treasury yields, which move inversely to

prices, jumped to their highest levels since November 2023, with

the 10-year hitting a high of 4.79%. Yields have gained 20 basis

points since the beginning of the year amid a global government

bonds selloff that has hit UK government bonds particularly

hard, pushing 30-year gilt yields to their highest since 1998.

Many in the bond market fear further weakness lies ahead, as

fiscal and trade policies under the upcoming Donald Trump

administration could lead to more Treasury issuance and a

rebound in inflation. A BMO Capital Markets client survey before

the jobs report showed 69% of respondents expect 10-year yields

will test 5% at some point this year.

Next week's economic reports will feature December's

producer and consumer price inflation data, which could be key

for the direction of yields.

The yield curve comparing two-year with 10-year yields has

steepened in recent weeks because 10-year yields have been

rising while shorter-dated ones have remained flat, a so-called

"bear steepening" dynamic, bad for long-term bond prices,

indicating the market expects interest rates to remain high due

to ongoing resilience in the economy.

But that could change should inflation rise again, warned

Jack McIntyre, a portfolio manager at Brandywine Global.

"Look for Treasury market to shift to a bear flattening from

its recent bear steepening trajectory," he said in a note. Bear

flattening occurs when short-term interest rates rise faster

than long-term interest rates, which can happen when investors

anticipate central banks will increase interest rates.

Outside of bonds, rising U.S. Treasury yields could dampen

investor interest in stocks and other high-risk assets by

tightening financial conditions and increasing borrowing costs

for businesses and individuals.

Higher yields can also improve the attractiveness of bonds

against equities, "with 5% still seen as a trigger point for

asset allocation shifts," said BNY in a recent note.

In late 2023, stocks declined when benchmark 10-year yields

reached 5% for the first time since 2007, and while they largely

shrugged off the increase in yields late last year as the move

was linked to an improved economy, stocks tumbled this week as

upbeat economic data propelled yields higher.

The S&P 500 was down 1% on Friday.

"The 10-year yield will remain above 4% this year and as a

result it could be quite challenging for the stock market," said

Sam Stovall, chief investment strategist of CFRA Research, after

the jobs data. "We started the year on the wrong foot."