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Short-term US government debt sells off sharply on inflation surge

Shorter-term US government bonds sold off sharply on Wednesday after the labour department reported consumer prices soared last month, underscoring concerns the Federal Reserve will need to act more decisively to slow inflation.

Two-year Treasury notes, which are highly sensitive to interest rate expectations, had the sharpest rise in yields since the market ructions during the height of the coronavirus crisis in March 2020. The yield reached a high of 0.51 per cent and was last up 0.08 percentage points to 0.50 per cent, pointing to a significant fall in price. The biggest move was in the five-year yield, which was last up 0.11 percentage points at 1.19 per cent.

Bonds with shorter-dated maturities rose in price last week after Jay Powell, Fed chair, vowed to take a “patient” approach to raising interest rates on expectations that such high levels of inflation would prove to be fleeting. However, the data released on Wednesday showing US consumer prices climbed 6.2 per cent in October from the same month in 2020, well above expectations of 5.8 per cent, have cast doubt on that pledge.

“I don’t see how the Fed can afford to wait,” said Tom Graff, head of fixed income at Brown Advisory. “The pressure is getting awfully high for some sort of response.” Graff said that if inflation continued at this rate the central bank might be forced to accelerate its quantitative tightening so that it ends this winter.

Eurodollar futures, a closely watched measure of market expectations of interest rate rises, show that investors are pricing in a 75 per cent chance of a rate increase as soon as June 2022 and 100 per cent chance of a rate rise in July.

“There are still concerns that the Fed is going to move away from its transitory narrative and pull a pivot on the market,” said Chris Jeffery, head of rates and inflation at Legal & General Investment Management.

Such a move could restrict economic growth, he added, “so people are positioning for [the central bank] bringing rate hikes forward then having to unwind them after that”.

An important market measure of inflation — the 5-year break-even inflation rate, which reflects where investors expect inflation will be in five years’ time — rose to the highest level on record to 3 per cent, according to Bloomberg data.

Longer-dated Treasuries, which provide a snapshot of investor expectations for economic growth and inflation further in the future, saw a more measured sell-off. Yields on the benchmark 10-year bond, however, still rose 0.07 percentage points to 1.52 per cent, its highest level this week.

The dollar index, which measures the US currency against six others, rose 0.6 per cent.

Global concerns over inflation were also inflamed by data released earlier on Wednesday, showing that Chinese producer price inflation — the measure of what businesses pay each other for goods — rose 13.5 per cent in October from the same time last year, its biggest leap in 26 years as factories absorbed higher energy prices.

The growing fears over rising prices globally also gripped the bond markets of the UK and Canada, where central bankers have signalled a readiness to move to combat price rises. The two-year UK gilt yield rose 0.11 percentage points to 0.55 per cent. The equivalent Canadian bond yield added 0.08 percentage points to reach 0.99 per cent.

Stock markets mostly shrugged off the inflation data, however. Equities have pushed to a series of record peaks in recent weeks despite inflation worries, as corporate earnings updates have indicated companies have passed on higher prices to customers instead of sacrificing profits.

The S&P 500, which ended its longest streak of all-time closing highs since 1997 on Monday, drifted 0.2 per cent lower. The technology-focused Nasdaq Composite lost 0.5 per cent. Technology stocks are more susceptible to inflation because their valuations are often based on future growth, the prospects of which are eroded by higher prices.

Europe’s Stoxx 600 share index, which has risen for 16 of the past 20 sessions, ticked 0.2 per cent higher.

Asian markets mostly fell on Wednesday in response to the surge in Chinese factory gate inflation, which L&G’s Jeffery said would dent “optimism about seeing some monetary policy action” from Beijing to support the nation’s ailing real estate sector.

China’s CSI 300 share index declined 0.5 per cent while the Nikkei 225 in Tokyo closed 0.6 per cent lower.

Other market moves:

  • US dollar high-yield bond issuance has notched an annual record of over $466bn, already surpassing 2020’s full-year total of nearly $460bn. In a further sign of how wide open capital markets are for companies looking to refinance or even repay debt, GE announced a $23bn tender offer for its bonds on Wednesday.

  • Brent crude, the oil benchmark, fell by 0.8 per cent to $84.12 a barrel.

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