The U.S. Treasuries shook off the steepest jump to consumer price inflation in four decades, with figures showing widespread anticipation that the Federal Reserve will raise interest rates in March.
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The December inflation figures were in line with the bond market expectations, and while benchmark Treasury yields initially rose moderately across the curve soon after the release, buyers began to emerge. The consumer price index increased by 7% last year, while the core rate, which excluded food and energy costs, was a little hotter, expanding at a rate of 5.5%, compared to an expected 5.4%.
The reaction was muted because yields have already gone up since the beginning of the year as traders brace for the Fed to hike rates and wrap up bond purchases that have flooded markets with cash for nearly two years. Ahead of the inflation report, positioning in the broad Treasury market was the most net bearish since late 2017 according to the latest survey by JPMorgan Chase Co.
Gregory Faranello, head of U.S. rates at AmeriVet Securities, said the market has aggressively refriced expectations for tighter Fed policy since the beginning of the year.
The policy sensitive two-year note yield was little changed at 0.89% after earlier rising by as much as 3 basis points, while the benchmark 10 year note yield fell below 1 basis point at 1.73% in the wake of a brief jump above 1.75%. Interest-rate futures were at an 88% probability of a quarter-point rate hike in March.
Another test of investor sentiment beckons with the sale of $36 billion 10 year notes on Wednesday amid a volatile start to the year. The reopening will be the highest yield since January 2020 and may entice buyers after a sharp rise in the benchmark's yield from 1.51% at the end of last year.
Faranello said that the auctions should be well supported at these levels for 10 and 30 year yields.
The bond market started the year with a selloff on anticipation that the central bank's monetary policy is poised to be rolled back as the U.S. economy suffers through a period of elevated inflation pressure and wage gains are growing at a robust pace. Jerome Powell, Chair of the Fed, said the central bank would use its tools to prevent inflation from becoming an issue at his confirmation hearing before the Senate Banking Committee on Tuesday.
Powell told lawmakers that if inflation persists at high levels longer than expected and we need to raise interest rates more over time, we're going to do it. Other Fed officials have lent weight to the idea of raising rates in March, while advocating for a reduction of the central bank's $8.8 trillion balance sheet later this year.
Steven Blitz, chief U.S. economist at TS Lombard said the Fed's focus is not on CPI per se; its wages, and there are good reasons to expect higher wage inflation in the coming year. Inflation psychology takes hold when people expect their wages to go up. The bond market has looked past high inflation reports in the past, with many expecting a moderation over the coming year as long-term disinflation trends of technology, greater automation and aging populations offset the current pandemic-related pressure. Treasury breakeven rates for the next 5 and 10 years peaked last November and were down around 3 basis points after the latest figures were released on Wednesday at 2.89% and 2.55% respectively. No Solar Power and Battery Storage Will Be the Real Test for Tesla?
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