With the rebound in Crude Oil prices, progress on the Biden stimulus, and rising expectations of an economic recovery, U.S. Treasury rates have continued to move higher, while Inflation expectations have hit a new high since 2014.
The U.S. 30-year Treasury yield has now risen 3 basis points to 2%, the highest level since February 2020, reaching the Fed’s inflation target and has been trending higher since hitting a low of 1.16% in August.
And, growing expectations of higher CPI are reflected in rising interest rates on inflation-linked debt: the difference between 10-year U.S. bonds and inflation-protected Treasuries – the 10-year break-even rate – also touched 2.21% at one point, reaching its largest level in 2014.
Previously in history, the Fed’s target inflation indicator lagged the CPI by about 40 basis points on average. This means that the break-even rate only needs to reach about 2.4% to achieve the target. The indicator has now climbed from a low of 0.5% last March and has depressed real yields and driven the 10-year inflation-adjusted rate to a record low of -1.12% in September and stabilized near -1.02% in recent weeks.
Mohit Kumar, managing director at Jefferies International, said Yellen and Lagarde’s comments on fiscal policy and the news that the Senate had opened a fast track for fiscal stimulus opened the market’s imagination to higher risk assets and bond yields.
However, economic data showed that the CPI index stood at 1.4% as of December, well below the Fed’s target. This raises concerns and questions about whether the prospect of targeted inflation will materialize immediately.
Richard Kelly, head of global strategy at Toronto Dominion Bank, said it’s more a matter of market liquidity than massive inflation. He advises investors to short 10-year Treasuries and anchor a steeper yield curve.
Kit Juckes, chief foreign exchange strategist at Societe Generale, said the focus is now on the impact of U.S. bond supply on yields, on U.S. fiscal policy and Federal Reserve monetary policy, and on the U.S. Treasury’s plans to cut cash balances. He also said that any impact on risk sentiment and the dollar would be offset by a rise in long-term yields.
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