Global Bonds Look to Powell as Inflation Surges Test Nerves
(Bloomberg) -- The global bond rally is under threat from inflation surprises, weak auctions and central banks withdrawing support. Where it goes next depends on Federal Reserve Chair Jerome Powell and his take on the narrative of transitory price pressures.
U.K. gilts and rate-hike bets were rocked by inflation data on Wednesday that mirrored the upside surprise in the U.S. the previous day. Meanwhile, the Reserve Bank of New Zealand unexpectedly ceased quantitative easing in a possible prelude to a rate hike, driving yields on benchmark bonds up by as much as 11 basis points to 1.78%. That turns the spotlight on the Bank of Canada, which is expected to pare bond purchases later Wednesday.
The moves in global bond markets come after a day after notable volatility in Treasuries, with weak demand for the monthly 30-year bond auction unleashing a bout of steepening.
All that is weighing on traders ahead of Powell’s testimony to a House panel later on Wednesday, where legislators are likely to push him on the rapid price increases and demand that he accelerate the Fed’s exit sequence. The Fed chair’s prepared remarks, released ahead of his 12:00 pm New York time session on Congress, triggered some re-steepening of the yield curve and pushed up bond-market gauges of inflation.
“At our June meeting, the committee discussed the economy’s progress toward our goals since we adopted our asset purchase guidance last December,” Powell said in his prepared remarks. “While reaching the standard of ‘substantial further progress’ is still a ways off, participants expect that progress will continue.”
The gap between 5- and 30-year yields steepened slightly on the day after Powell’s comments were released, moving to as wide as more than 120 basis points. That was up from as low as 117.5 basis points earlier in the session. The 10-year break-even inflation rate, the bond market’s proxy for the annual pace of inflation over the coming decade, reversed an earlier decline to trade at slight gains on the session at about 2.38%.
Questions over the U.S. policy path come against a backdrop of growing divergence between central banks like New Zealand’s that are already easing off debt purchases, and those signaling more support, like the European Central Bank and People’s Bank of China.
“The U.S. Treasury market is the market most capable of spooking others if yields all along the curve continue to rise,” said Steen Jakobsen, Chief Investment Officer at Saxo Bank. Given Powell’s testimony comes “just after the very hot June inflation print, the questions could be a bit more pointed on whether the Fed is allowing things to run too hot.”
U.S. consumer price readings surged last month by the most since 2008, emboldening traders to bet the Federal Reserve will tighten policy in early 2023.
“The inflation genie could be out of the bottle as the inflation picture looks less and less transitory,” Sung Won Sohn, president of SS Economics and a professor at Loyola Marymount University wrote in a note. “To be sure, the supply bottlenecks, a surge in demand and the base effect explain some of the increases, but it is difficult to argue that everything will be back to normal in a few months.”
Fed officials foresee two hikes by the end of 2023, according to the median estimate of their projections published last month. Yet Boston President Fed Eric Rosengren as well as St. Louis Fed’s James Bullard, Dallas’s Robert Kaplan and Atlanta’s Raphael Bostic have all publicly laid out a scenario in which the central bank would lift rates next year.
Now, the bond market is awaiting its cues from Powell and traders are bracing for any global repricing on any signs of a more hawkish approach.
U.S. Treasuries pared some of Tuesday’s move, with 10-year yields down three basis points at 1.37% as of 9:00 a.m. in New York -- with the benchmark rate seeing little reaction to Powell’s prepared remarks. After rising five basis points the previous day, yields on the long bond fell three basis points to 2%.
U.K. gilts underperformed Treasuries and bunds after the hot inflation print, with benchmark yields rising four basis points to 0.67% and the curve steepening.
“Overnight and today puts to bed the idea that the Fed is the only game in town,” said Jordan Rochester, a strategist at Nomura in London.
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