U.S. 10-year yields climb to two-year peak on Fed hike, balance sheet view

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  • U.S. jobs headline number lower than expected
  • Two-year, 5-year yields hit highest since March and January 2020
  • U.S. 10-year yields hit a two-year high at 1.8%
  • Fed fund futures show 80% chance of hike in March
  • Fed's Daly says Fed could shrink balance sheet after a few hikes

NEW YORK, Jan 7 (Reuters) - U.S. benchmark Treasury 10-year yield soared to a two-year high on Friday, as a mixed U.S. nonfarm payrolls report that showed fewer-than-expected new jobs created in December was viewed as good enough to keep the Federal Reserve on track to raise interest rates at its March meeting.

The U.S. 10-year yield rose to 1.801% , the highest since January 2020.

U.S. 10-year yields have gained about 25 basis points this week, its best weekly rise since September 2019.

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A big part of the jump in yields this week was the release of the Fed minutes on Wednesday, which suggested an earlier-than-expected rate hike and the possibility that the Fed may cut its bond holdings sooner than many initially thought.

San Francisco Fed President Mary Daly, who is not a voter this year, on Friday weighed in on the balance sheet debate. She said she could see the Fed shrinking its more than $8 trillion balance sheet soon after it has raised rates once or twice. read more

Fed funds futures imply an 80% chance of a 25-basis point tightening by March on Friday, and more than three rate hikes by the end of the year. .

"There's a clear spirit of a move toward quicker (balance sheet) runoff relative to the Fed's liftoff date. But there was no mistaking, once the first rate hike is done, it's on the table," said Gregory Faranello, head of U.S. rates at Amerivet Securities in New York.

On the shorter-end of the curve, U.S. 2-year and 5-year yields, which reflect the market's interest rate outlook, rose to their highest since March and January 2020, respectively.

U.S. 30-year yields, meanwhile, scaled new 11-week peaks.

The yields surged after a U.S. jobs report showed some positive elements, such as the decline in the unemployment rate and an increase in wage growth.

U.S. nonfarm payrolls rose 199,000 last month, data showed. Market forecast showed payrolls rising by 400,000.

The unemployment rate dropped to 3.9% from 4.2% in November, underscoring a tightening labor market, while average hourly earnings rose 0.6% in December, up from 0.4% the previous month. read more

In late afternoon trading, U.S. benchmark 10-year yields were last up 3 basis points at 1.7673%.

"We should get a lot of two-way activity in the mid-1.80s," said Jim Vogel, senior rates strategist, at FHN Financial in Memphis, Tennessee. "It makes far more sense for 10s to hang around the 1.70s area or go into the mid-1.80s as the next central clearing point."

U.S. 30-year yields hit a fresh 11-week peak of 2.145%, and was last up 2 basis points at 2.1137%. The yield was up about 21 basis points this week, the biggest weekly advance in a year.

U.S. 2-year yields rose to 0.908% , the highest since March 2020, and were last down 1 basis point at 0.8611%. They were up nearly 14 basis points this week, their largest weekly gain since October 2019.

U.S. 5-year yields advanced to its highest since January 2020 of 1.525%. They were last up 2 basis points at 1.5003% . On the week, U.S. 5-year yields were roughly 24 basis points, their largest increase since September 2019.

The most active CBOT 10-year Treasury note futures contract , where speculators can make leveraged bets and hedge against the benchmark U.S. government note, plunged in price to its lowest since February 2020.

One measure of the U.S. yield curve, meanwhile, steepened on Friday, after flattening in the last two sessions. The gap between 2-year and 10-yields rose 89.70 basis points , the flattest since mid-December.

January 7 Friday 4:13PM New York / 2113 GMT

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Reporting by Gertrude Chavez-Dreyfuss; Editing by Jonathan Oatis and Nick Zieminski

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