Treasury Yields Top 1.75% After Powell Spurs Bets on Inflation

Treasury yields breached key levels as traders boosted bets the Federal Reserve will allow inflation to overshoot amid an economic rebound.

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 jumped to 2.5% for the first time since August 2019. Market measures of inflation expectations are 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. Treasury yields pared some gains but remained elevated during New York morning trading.

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 pickup 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.”

Treasury Yields Top 1.75% After Powell Spurs Bets on Inflation

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.

Block trades throughout the session kept the long-end under pressure, with cash buying later emerging as the gap between the 7- and 30-year yield pushed to the flattest levels of the day. The belly of the curve experienced large moves, with the five-year yield climbing as much as 10 basis points to just under 0.90% and the seven-year rate pushing ahead as much as 11.2 basis points to just shy of 1.39%, the highest since February 2020.

Treasury 10-year yields are likely to hit 2% as traders are “coming to the view that stronger U.S. growth, and a Fed more tolerant of higher inflation, mean there is further upside for bond yields,” said Khoon Goh, strategist at Australia & New Zealand Banking Group Ltd.

Treasury Yields Top 1.75% After Powell Spurs Bets on Inflation

“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.”

Treasury Yields Top 1.75% After Powell Spurs Bets on Inflation

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 also widened to its largest since March 2020. Meanwhile, U.K. gilts pared losses after the Bank of England maintained its pace of stimulus and said it won’t tighten monetary policy until there’s clear evidence of an economic recovery.

READ: U.S. Traders Hitting ‘Sell Button’ Push ECB Into Tight Corner

Treasury Yields Top 1.75% After Powell Spurs Bets on Inflation

While many including BlackRock Inc. say expectations for sustained inflation gains are misplaced, others note 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.”

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