Treasuries Inflation Gauge Exceeds 2% for First Time Since 2018

Traders see U.S. inflation averaging at least 2% per year over the coming decade, the first time expectations have climbed that high since 2018. Treasuries Inflation Gauge Exceeds 2% for First Time Since 2018

The move came as real yields plumbed record lows.

The 10-year breakeven rate — a measure that draws on pricing for inflation-linked Treasuries — rose as high as 2.017% Monday, a level last seen more than two years ago, data compiled by Bloomberg show.

The gauge has gained momentum as traders prepare for an uptick in the world economy in the wake of a deal on Brexit and the approval of additional virus-relief aid in the U.S. The roll-out of vaccinations against the coronavirus is also fueling the move higher, as is speculation that Tuesday’s U.S. Senate runoff elections in Georgia could give Democrats control of Congress.

“There’s a general expectation that the increase in demand as things return to normal will lead to higher inflation because supply chains are still disrupted,” said Michael Pond, head of inflation-linked market strategy at Barclays Capital. The possibility that Democrats will win Tuesday’s votes creates additional upside potential for breakevens, he said. “If we do have unified government, more can get done and we’ll probably see a bit more fiscal stimulus.”

The Federal Reserve is setting the tone for markets, making a renewed push to revive inflation — which has been too low for years. In August, policy makers announced that they would seek inflation that averages 2% over time by allowing price pressures to overshoot after periods of weakness. Buoying expectations for inflation is key to lifting inflation itself, officials have said.

Aided by a rebound in energy prices, the breakeven rate has widened steadily since November, after Joe Biden won the U.S. presidential election. Biden has nominated former Fed Chair Janet Yellen to head the Treasury, which some investors see signaling the potential for stronger cooperation between the department and the central bank.

The flip side of the climb in inflation expectations is that real yields — which strip out the effects of inflation — have been spiraling lower. Ten-year real rates sank to a record low of about minus 1.124% on Monday.

Updated: 1-6-2021

Treasuries Breaching 1% On Democratic Win May Just Be The Start

U.S. Treasury yields broke above 1% for the first time since the pandemic-driven turmoil in March, and the selloff may only have just begun should the Democrats secure control of the U.S. Senate.

The 10-year yield, a key global benchmark interest rate, at one point surged close to 10 basis points to more than 1.05% as Democratic victories appeared likely in both Senate runoff elections in Georgia, paving the way for more spending to revive the U.S. economy. Long-bond rates, meanwhile, were on track for their biggest one-day jump since March’s pandemic-related turmoil and investors have already started to dust off reflation trades in anticipation of a so-called Blue Sweep.

“The result will certainly be seen as a driver of higher Treasury yields,” said James Athey, a money manager at Aberdeen Standard Investments. “The reflation trade has already been sparked. The question really is how much further the Senate result will push that.”

Should 10-year yields climb higher from 1%, investors said it could spark a domino effect across asset classes if the increase is accompanied by economic recovery and moderate levels of inflation. A gauge of the dollar approached the lowest level since 2018 and most commodity prices rose.

The spread between five- and 30-year bond yields hit its steepest level since November 2016, when Donald Trump’s election sparked trades premised on stronger growth and higher inflation.

The 30-year yield at one point rose close to 13 basis points on the day and even after paring its move slightly remained on course for the biggest single-day advance since March. Back then, the turmoil surrounding the pandemic drove a number of daily moves both ways in excess of 20 basis points, including a 40 basis point shift on March 17.

While the pandemic is still raging with the rollout of vaccines in the early stages, the risk is that further signs of inflationary pressure will start to see bets on Federal Reserve rate hikes materialize.

U.S. 10-year breakevens, a market gauge of inflation expectations over the next decade, topped 2% this week for the first time since 2018, having gained in each of the last three months. At around 2.09%, the measure is within sight of 2018’s high of 2.2078%, and a breach of that level would put it in territory unseen since 2014.

European longer-dated government bonds also fell, with the German 10-year yield rising more than five basis points.

“It’s a clear steepener trade and fixed-income selloff,” said Richard Kelly, head of global strategy at Toronto-Dominion Bank. “The initial reaction here should be ‘fiscal on,’ and that does support higher rates.”

Blue Sweep

Democrat Raphael Warnock ousted Republican Kelly Loeffler in Georgia, the Associated Press reported, leaving control of the chamber in question until the result of the state’s other runoff election is decided.

Treasury yields gained ahead of the U.S. elections in November, propelled in part by the expectation of more stimulus under a Democratic administration. The breach of 1% completes a journey that began on March 3, when early indications of what the pandemic might mean for the U.S. economy pushed the yield below that level for the first time. Over the following week, it fell to a record low 0.314%.

Higher yields will lead the Federal Reserve to intervene only if the move jeopardizes current easy financial conditions, according to Ed Al-Hussainy, a portfolio strategist at Columbia Threadneedle. He sees potential for the 30-year Treasury yield to climb to 2.25%-2.50%, from the current 1.78%.

“I can see 10-year Treasury yields rising to 1.5% to 2% in short order if more and more uncertainty gets behind us,” said Vishnu Varathan, head of economics and strategy at Mizuho Bank Ltd in Singapore.

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