Inflation Fears Wrack Bonds as Fed Seen Hiking Twice Next Year

(Bloomberg) — Treasury yields have surged this week, with shorter-maturity rates touching the highest since the start of the Covid outbreak, as concern over quickening inflation drove traders to price in two U.S. interest-rate hikes by the end of next year.

Most Read from Bloomberg

The yield on five-year notes climbed above 1.20% on Thursday for the first time since February 2020, while that on benchmark 10-year debt topped 1.70%. Treasury Inflation-Protected Securities outperformed nominal Treasuries on speculation cost pressures in the economy will test the Federal Reserve’s resolve to keep borrowing costs low as the economy recovers.

The U.S. five-year yield has risen 10 basis points this week and reached as high as 1.24% on Thursday. The 10-year yield has climbed 12 basis points over the same period. Around 52 basis points of tightening are priced in by the end of 2022, equivalent to two quarter-point hikes.

With a Fed decision to begin winding down asset purchases “all but a foregone conclusion,” the timing of rate hikes is what’s at stake, and “the expression of that will be most readily apparent in the belly of the curve,” said Ben Jeffery, a strategist at BMO Capital Markets in New York. “Going into the next Fed meeting, we should look for the ability of risk assets to withstand higher yields in the five-year sector and also how market-based inflation expectations respond.”

BMO expects the first rate hike in late 2022 or early 2023, he said.

The break-even rate for five-year TIPS surged Thursday to the highest since the maturity was reintroduced in 2004. The move was particularly striking as it coincided with the largest-ever auction of the tenor. The $19 billion offering drew a record-low yield of minus 1.685%, below where it was trading before the auction, a sign that demand exceeded dealers’ expectations.

Story continues

“Even for an auction day, dealers report it as a high-volume day,” said Gang Hu, managing partner at Winshore Capital Partners LP in New York. “The market is very small and when money comes in, it doesn’t take a lot to move around TIPS prices.”

Activity in the rate options market during U.S. trading hours included a $10 million wager targeting a further increase in the five-year nominal yield to around 1.33% by the end of November.

Most Read from Bloomberg Businessweek

©2021 Bloomberg L.P.

Source: https://ca.finance.yahoo.com/news/u-5-tops-1-2-141304830.html