(Bloomberg)–Treasuries tumbled, driving two-year yields to a 17-year high, after a surprisingly large jump in retail sales last month increased speculation that the Federal Reserve will raise interest rates again.

Yields rose across the maturity spectrum, each by at least 10 basis points at one stage. The two-year note’s rose to 5.207%, last seen in 2006, exceeding its Sept. 21 high. Investors are demanding higher risk-free rates of return based on the strength of the US economy despite the threat of a broader Middle East conflict, which last week drove investors into US government bonds as a haven.

The 10-year Treasury yield approached 4.86%, just shy of the year-to-date peak reached on Oct. 6, which was the highest level since 2007. Some short-dated option trades sought to hedge the risk of a rise beyond 4.95% before the end of the month. “A retest of the recent yield highs” appears likely, said Gregory Faranello, Head of US Rates Trading and Strategy for AmeriVet Securities. “Despite a small pocket of flight-to- quality with the events in the Middle East, the long end continues to struggle.”

The moves extended the volatility that has whipsawed the bond market with unusually large price movements over the past week as was broke out between Israel and Hamas. With yields swinging up and down by 10 basis points or more each day over the past week, it’s been the most volatile stretch since the pandemic-fueled turbulence of March 2020.

“Rates can move higher until something breaks,” said Jack McIntyre, portfolio manager at Brandywine Global Investment Management. “Investors are wrestling with the question: do you need the economy to break to get inflation lower, or will inflation come down on its own.”

Swap contracts tied to Fed rate decisions showed traders are pricing in roughly 60% odds that policymakers will raise interest rates by another quarter percentage point in January after holding steady in November. A move in December is considered a tossup.

There’s also been pressure on longer-dated Treasuries because of the increase in new debt sales needed to cover the swelling federal budget deficit.

Last week, all three of the US government’s auctions of notes and bonds drew higher-than-anticipated yields, a sign that demand fell short of expectations. A sale of 20-year bonds is ahead on Wednesday. Investors globally are showing wariness toward long-dated debt. Demand was weak for an auction of 20-year Japanese government bonds Tuesday.

In the initial reaction to the US September retail sales report, long-dated yields rose most, steepening the yield curve. The 10-year note’s yield climbed to within 0.32 percentage point of the two-year note’s. Long-dated yields subsequently retreated from their highs, and the inversion returned to around 0.40 percentage point.

— By: Michael Mackenzie with assistance from Elizabeth Stanton.