By Min Zeng

Wall Street has never been so sure that interest rates are about to rise.

Investor bets on rising U.S. short-term rates hit the highest ever last week in the eurodollar-futures market, at $2.1 trillion. That breaks a record set in 2014, said Cheng Chen, U.S. rates strategist at TD Securities, citing data from the Commodity Futures Trading Commission going back to 1993.

It is the latest sign that the election of Donald Trump is reshaping financial markets around the globe. Investors have been scrambling for the past two weeks to position themselves for a Trump presidency that they believe will mean higher growth, higher inflation and a Federal Reserve that will be under pressure to raise interest rates in a way that hasn't been seen for more than a decade.

Already, the Trump trade has sent the three major U.S. stock indexes to their first daily triple-record close since August, with the Dow industrials on Monday closing in on their first-ever settlement above 19000. The ICE Dollar Index, after rising 10 straight sessions to its highest level since 2003, declined 0.3% Monday to 100.92.

Bond prices have slumped, reflecting investor fears that inflation will eat away at the value of their fixed payments, reversing the sharp appreciation seen earlier in 2016 and sending the 10-year Treasury yield to 2.335%, up from 1.867% on U.S. Election Day and near its highest since last holiday season. The two-year Treasury yield rose Monday to 1.084%, closing in on levels last seen in 2010. Yields rise as bond prices fall.

"It has been a sea change over the past few months," said James DeMasi, chief fixed-income strategist at StifelNicolaus Co.

It was just four months ago that the 10-year Treasury yield hit its all-time low at 1.366%, aided by a flight to safety driven by the U.K. vote to exit from the European Union.

At the time, many investors warned that buyers of long-term government bonds at near-zero yields were taking on significant risk in betting that inflation would remain quiescent for a decade or more. But even among skeptics, few expected the reversal to get under way so quickly.

The market in fed-fund futures put 95% odds late Monday on a U.S. rate increase at the Fed's meeting in December, according to CME Group data. That is up from 58% two months ago and 12% in late June.

With the shift, market expectations have come essentially into line with the Fed's own projections for two rate increases during 2017. The risk is that expectations for rate increases may accelerate, pushing up interest rates and the value of the dollar, effectively tightening financial conditions and complicating the central bank's efforts to slowly wean the economy off stimulative policy.

Fed Chairwoman Janet Yellen told lawmakers last Thursday that the Fed could move "relatively soon." Ms. Yellen warned that holding off on a rate increase for too long could force the Fed to raise rates relatively abruptly in the future to keep the economy from overheating. But she said the near-term risk of "falling behind the curve" soon is limited, and reiterated that the bank expects to raise rates gradually over the next few years.

Mark Cabana, head of U.S. short-rates strategy at Bank of America Merrill Lynch, said government bond yields are likely to rise further.

At the same time, the scale of the rising-rate bet is raising eyebrows following a series of reversals in once-popular bets on dividend stocks, gold and other so-called lower-for-longer plays. Crowded trades increase the risk that anygiven disappointment can fuel outsize losses, some analysts say.

Others warn that a strengthening dollar and rising U.S. rates risk intensifying a chronic funding squeeze in emerging markets where dollar borrowing has boomed since the financial crisis, potentially fueling a sharp retreat from stocks, commodities and other riskier assets.

"Are we going to see another China panic episode?" said Blake Gwinn, U.S. rates strategist at RBS Securities, referring to the August 2015 and January 2016 market routs. "So far things seem to be orderly, but the risk is out there."

Write to Min Zeng at min.zeng@wsj.com

(END) Dow Jones Newswires

November 22, 2016 08:37 ET (13:37 GMT)

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