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US services sector activity jumped to 1-1/2-year high

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Expectations for another 50 bps rate cut remain lower than

a

week ago

(Updates as of 1442 EDT)

By Matt Tracy

WASHINGTON, Oct 3 - U.S. Treasury yields climbed on

Thursday after strong services sector data supported forecasts

for a smaller interest rate cut at the Federal Reserve's

November meeting than in September.

U.S. services sector activity jumped to a 1-1/2-year high in

September, accelerating to its highest level since February

2023, according to the Institute for Supply Management's

non-manufacturing purchasing managers index released Thursday.

Yields on U.S. government bonds rose following this and

other economic data released on Thursday. U.S. 10-year yields

climbed to their highest since Sept. 3 and were last

up 5.3 basis points at 3.841%.

Initial jobless claims figures, also released on Thursday,

showed the number of Americans filing new applications for

unemployment benefits rose slightly more than expected last

week.

The two-year U.S. Treasury yield, which typically

moves in step with interest rate expectations, rose to its

highest since Sept. 18 and was last up 5.7 bps at 3.705%.

A closely watched part of the U.S. Treasury yield curve

measuring the gap between yields on two- and 10-year Treasury

notes, seen as an indicator of economic

expectations, was last at a positive 13.7 bps, little changed

from 13.6 bps late Wednesday.

The market has gone back and forth in recent days over the

extent of an expected second Fed rate cut at its November

meeting, following its 50 bp cut last month. Expectations for a

25 bp cut at the Fed's November meeting inched higher following

the data, with markets pricing in a 65% chance, with a 35%

chance of 50 bps priced in, according to CME's FedWatch tool.

"The market is trying ever so carefully to price out a 50 bp

rate cut, but it's not fully priced out yet," said Subadra

Rajappa, head of U.S. rates strategy at Societe Generale.

Rising yields on Thursday followed a dip earlier in the week

when investors sought the safety of Treasuries after Iran

launched more than 180 missiles against Israel in escalating

Middle East tensions. Meanwhile, a strike at U.S. East Coast and

Gulf Coast ports, which began on Tuesday and is now in its third

day, also poses an inflation risk.

"Military conflicts are inflationary, and there's a good

relationship between oil prices and yield moves," said Jack

McIntyre, portfolio manager at asset manager Brandywine Global.

"When it comes to the port strikes, that's a wild card."

Market participants are most focused on the Friday release

of the government's more comprehensive payrolls and employment

report for September. Fed Chair Jerome Powell and other Fed

officials have signaled the central bank's primary focus has

shifted from combating inflation to ensuring a stable labor

market.

"There is some selling that's taking place in front of the

nonfarm payroll number tomorrow," said Tom di Galoma, head of

fixed income trading at Curvature Securities.

The breakeven rate on five-year U.S. Treasury

Inflation-Protected Securities (TIPS) was last at

2.141%, 0.017% higher than Wednesday's close of 2.124%.

The 10-year TIPS breakeven rate was last at

2.213%, indicating the market sees inflation averaging about

2.2% a year for the next decade. That was about 0.004% below its

Wednesday level.