Treasuries extended their slump in New York, driving the yield on the benchmark 10-year note up by the most in more than three weeks, as renewed inflation concerns and economic data supported expectations for multiple Federal Reserve rate hikes in coming months.
Intermediate-dated benchmarks led the decline, with yields on five-, seven-and 10-year Treasuries rising by around 12 basis points. The moves were spurred by hawkish comments from Fed Governor Christopher Waller and gained steam after stronger-than-expected reports on US consumer confidence and Chicago-area business conditions.
Reinforcing speculation that central banks are set to tighten policy during the summer, oil advanced to a two-month high while European inflation data for May exceeded economists’ forecasts.
“There is a lot of inflation uncertainty,” said Gregory Faranello, head of US rates trading and strategy for AmeriVet Securities. “It’s one thing to have an energy price shock, another matter to see that being sustained for a longer period of time.”
Traders are almost fully pricing two half-point rate increases over June and July, and see even odds of a third such hike in September, swaps show. The trajectory of Fed policy rests with how inflation behaves in the coming months.
“If inflation is still running hot as we work toward the September meeting, barring extreme market dislocations, the Fed will be prepared to do more,” said Faranello.
Others worry that inflation has become entrenched and that central banks will need to tighten policy beyond the neutral rate, which is seen around 2.5% for the US economy.
“Inflation has become self-sustaining, and bringing it back under control will be harder and more painful than the central bank hopes,” Sonal Desai, chief investment officer for fixed income at Franklin Templeton, wrote in a research note. “The Fed’s tightening cycle will be longer, and policy rates and bond yields will have to go higher than markets currently expect.”
Despite Tuesday’s selloff, the US 10-year yield is still over 30 basis points below the high reached earlier this month. Investors are caught between elevated inflation and monetary policy tightening, which is aimed at slowing it but is also increasingly seen as a threat to the economy.
German bonds mirrored declines in their US counterparts after data showed euro-zone inflation accelerated to an all-time high. Benchmark 10-year yields rose 8 basis points to 1.13%, while the rate on equivalent Italian debt hit the highest in three weeks.
Money markets are pricing 115 basis points of European Central Bank tightening by December. While the ECB is preparing to lift borrowing costs for the first time in more than a decade, Bank of Italy Governor Ignazio Visco earlier reiterated the need for hikes to be “orderly.”
Still, many central bankers around the world see the need for bolder action. Fed Governor Waller, who on Monday argued for more rate hikes until price pressures recede, supports 50 basis points increases at “several” meetings.
The slump in Treasuries also looks to be driven by month-end portfolio rebalancing. JPMorgan Chase & Co. estimates such flows may cause a 1% to 3% outperformance in equities during the last week of May as pension funds shift allocations away from bonds. A big slate of corporate-bond sales may also be playing a role.
“There is a ton of corporate deals for a Tuesday after a Memorial day, and it could be a robust month as companies lock in borrowing before the slower months of summer,” said Faranello.
Still, Treasuries have still returned 0.8% in May, on course to halt five straight months of losses.
“I’m not completely convinced” that Treasury 10-year yields have seen the cycle high, Kit Juckes, a strategist at Societe Generale SA in London, wrote in a client note. “Chances are that Treasuries will turn the screw at least one more time, probably this summer as rates rise by another 100 basis points.”
(Updates price moves throughout.) --With assistance from Alice Gledhill and Edward Bolingbroke.
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