NEW YORK: US Treasuries are facing a perfect storm that could send benchmark yields to their highest level in almost two years, as investors fret over a more hawkish Federal Reserve, surging inflation and a deluge of supply. Benchmark 10-year yields on Thursday jumped to 1.753%, up from a low of 1.491% at year-end and 1.353% on Dec. 20. The yields are now holding just below the 1.776% level reached in March 2021, which was the highest yield since February 2020.
Analysts say a definitive break above technical resistance up to around 1.79% would likely signal further gains to the 2% area.
The latter half of 2021 saw several rallies in the benchmark yield, which moves inversely to bond prices, fail around current levels as markets were hit by worries over COVID-19, economic growth and as investors sought out US debt for its relatively higher yields.
Investors increasingly believe this time may be different, not least because a hawkish Fed appears ready to pull out the stops in its fight against surging inflation.
Yields took an extra leg higher after minutes from the Fed’s December meeting released on Wednesday showed that officials had discussed shrinking the US central bank’s overall asset holdings as well as raising interest rates sooner than expected to fight inflation.
“This talk about letting the balance sheet runoff and envisaging a future where there are no more Fed purchases_ people are going to prepare for that now,” said Tom Simons, a money market economist at Jefferies.
Other factors pressuring yields include corporate debt issuers locking in rates as they rush to beat rate hikes, and a broad market repricing of bonds after safe-haven demand helped to push yields too low relative to fundamentals at year-end.
Demand for bonds relative to supply is also expected to worsen this year as central banks pare back purchases. The Fed only two months ago was buying an extra $120 bln a month in bonds.
HAWKISH FED
The Fed is under pressure hasten the removal of its extraordinary accommodation as surging price pressures prove more stubborn than previously thought. The rapid spread of the Omicron coronavirus variant may also add to supply disruptions, potentially increasing upward pressure on inflation.
A surprisingly strong ADP National Employment Report on Wednesday also suggests that the labor market recovery may justify raising rates. The US government will release its highly-anticipated jobs report for December on Friday.
“It looks like the conditions for Fed rate hikes have pretty much been met with the labor market now pretty robust,” said Kim Rupert, managing director in global fixed income analysis at Action Economics, though she noted that holiday-season could have created data anomalies.
Fed funds futures are now fully pricing in three rate hikes by the end of 2022, with the first increase likely as soon as March.
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