Treasury yields breached more key levels as bond traders boosted bets that the Federal Reserve will allow inflation to overshoot as the U.S. economy recovers.
Yields on the benchmark 10-year note climbed as much as 11 basis points to 1.75% — the highest since January 2020, while the 30-year breached 2.5% for the first time since August 2019. Market measures of inflation expectations are now trading near multi-year highs, with traders paring back bets the Fed would start tightening as soon as late next year. The dollar rebounded against its major peers.
The moves came after Fed Chair Jerome Powell indicated he wasn’t concerned over the recent surge in long-term yields — with his focus still on whether financial conditions remained accommodative. Rates have surged this year on expectations that stimulus spending and vaccine rollouts will fuel a sharper economic recovery and a pick up in inflation.
“Powell has given the green light to higher 10- and 30-year yields as progress out of the pandemic accelerates,” said BMO Capital Markets’ Ian Lyngen. “Underlying inflation expectations remain elevated and will remain a bedrock of the bearish trend in Treasuries until those assumptions are challenged. For now, it doesn’t pay to fight the cheaper and steeper yield curve.”
Futures volumes surged after the benchmark 10-year yield broke past 1.7%, giving way to another bout of selling. Treasuries were already facing modest pressure in Asian hours before flows accelerated at the start of the London session and yields climbed to fresh highs in New York morning trading. Long positions amassed ahead of the Fed meeting were unwound, adding to the selloff.
“The overall tone from the Fed leaves the back end of the curve largely unprotected,” wrote ING Groep NV strategists led by Padhraic Garvey. There is “no real barrier to a test higher in the 10-year yield in the coming weeks.”
The reaction was more muted in European rates markets, with the European Central Bank striking a more concerned tone than the Fed on rising yields. That helped briefly push the spread between benchmark U.S. Treasuries and German bunds above 200 basis points for the first time in over a year. The comparable gap in real yields has also widened to its largest since March 2020.
While many including BlackRock Inc. say expectations for sustained inflation gains are misplaced, others see the risk of a substantial overshoot as being real. Deutsche Bank AG strategists see the U.S. 10-year yield rising to as much as 3% if price increases materialize sooner than expected.
“The Fed’s steady as she goes approach may clarify the fact that it intends to be reactive than pre-emptive but this does not address the uncertainty regarding the outlook for inflation,” said Richard McGuire, the head of rates strategy at Rabobank. “Investors cannot rely upon the bank getting ahead of the curve should that prove necessary.”