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U.S. Treasury yields jumped on Thursday after the Federal Reserve opened the door to raising interest rates by as early as next year, a potentially hawkish move that was reinforced by a fresh Bank of England outlook on rates and a rate hike by the Norwegian central bank.

Canadian bond yields also rose, with the five-year government note surging to just more than 1 per cent, a level it hasn’t seen since early summer and nearing yields prior to the pandemic. Five-year bonds are widely followed in Canada because of their influence on the direction of fixed mortgage rates.

Yields on the benchmark U.S. 10-year Treasury note shot above 1.4 per cent to their highest since mid-July as selling pressure on British gilts spilled into the Treasury market after the tightening message from the European central banks. Canada’s 10-year rose about 11 basis points to 1.332 per cent by late afternoon.

The sudden move higher in yields surprised the market after the muted reaction to the Fed’s hawkish position on Wednesday. The U.S. central bank said it would reduce its monthly bond purchases “soon” and half of the Fed’s policy makers projected borrowing costs will need to rise in 2022.

“The central banks are starting to finally get the message that they actually need to tighten. The pandemic’s basically over,” said Tom di Galoma, managing director of Seaport Global Holdings in Greenwich, Conn.

Bond prices, which move opposite to their yield, plunged in afternoon trading and tripped sell stops, said Kim Rupert, managing director, fixed income at Action Economics in San Francisco. Sell stops are automated orders to exit a position at a certain price level.

The hawkish shift among Fed policy makers, similar signs by other central banks and the risk rally in stocks weighed heavily on Treasuries, she said.

Treasury’s announcement of US$183 billion shorter-dated coupon auctions for next week, unchanged in size so far this year, also weighed, she said.

“Take a step back and just think about how low yields are even relative to where we were in the first quarter of this year,” said Zachary Griffiths, macro strategist at Wells Fargo in Charlotte, N.C. “We do have very high inflation, high economic growth forecasts and it’s really been kind of hard to justify where yields have been up to this point.”

The Bank of England said the case for higher rates “appeared to have strengthened,” leading interest rate futures to price in a 90-per-cent chance that the British central bank would raise rates by February. Short-dated British government bond yields soared to their highest since the market turmoil of March, 2020.

The bank nudged up its forecast for inflation at the end of the year to more than 4 per cent, more than twice its target rate. The Bank of England said it expected the overshoot to be temporary, but two policy makers called for an immediate halt to the British central bank’s £895-billion ($1.55-trillion) bond-purchase program, which is due to run until year-end.

Norges Bank raised its benchmark interest rate to 0.25 per cent from zero and expects to hike again in December, saying a strong recovery in the Norwegian economy made it time to start a gradual normalization of monetary policies. It became the first major central bank to tighten policy since the COVID-19 crisis began.

European Central Bank policy makers, meanwhile, are bracing for inflation to exceed the bank’s already-raised estimates, paving the way to end its emergency bond purchases in March, sources involved in the discussion said.

The U.S. five-year note rose above 90 basis points for the first time since early July after the Fed said on Wednesday it would reduce its monthly bond purchases “soon” and half of the central bank’s policymakers projected borrowing costs will need to rise in 2022, a more hawkish tilt than in the past.

The 10-year U.S. Treasury Inflation-Protected Securities (TIPS) breakeven rate was last at 2.338 per cent, indicating the market sees inflation averaging about 2.33 per cent a year for the next decade.

With files from Globe and Mail staff

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