Yardstick of future US inflation climbs to highest in over a decade

Inflation fears continued to mount in the US government bond market on Friday, as traders pushed bets on future price rises continuing to hit the highest levels in more than a decade.

The 10-year break-even inflation rate — a market measure of expected US inflation in a decade from now — rose to 2.76 per cent on Friday, its highest level since 2006. The five-year break-even rate, measuring the rate of inflation in five years, rose to 3.15 per cent, the highest position from data going back to 2002, according to Bloomberg.

The rising bets are the latest example of the fallout from Wednesday’s blockbuster consumer price index data, which showed that US inflation in October had risen at a rate of 6.2 per cent from the previous year. In response to the inflation figures, US Treasury bonds have sold off, as investors have bet the Federal Reserve will need to increase US interest rates sooner than previously expected.

US inflation has been running at 5 per cent or more since May, as prices have been pushed higher by coronavirus-related supply chain disruptions. But investors have been unsettled by signs of inflation broadening across several sectors, potentially weakening support for the Fed’s view of the price pressures as “transitory”.

The yield on the two-year Treasury note, which is sensitive to interest rate expectations, rose 0.01 percentage points to 0.52 per cent on Friday. The yield sat at around 0.43 per cent before Wednesday, when it rose by the most since the market turbulence of March 2020.

Another closely watched measure of interest rate expectations, eurodollar futures, showed that the market is currently pricing the first quarter-point rate increase as soon as June, with as many as three further increases by the end of next year.

Part of the reason that inflation expectations have reached such high levels on Friday is because five and 10-year Treasury notes have continued to sell off. The yield on the benchmark 10-year note rose by 0.03 points on Friday to 1.58 per cent.

While the five and 10-year break-even inflation rates have been rising, the real yields of both notes have been falling to near record lows. The real rate of a Treasury bond is the yield stripped of the effects of inflation. Real yields move with growth expectations, and the fall this week suggests investors think that raising rates too soon may hurt the US economy.

“What we’re seeing is two different parts of the market worried about two potentially different outcomes. The break-even complex saying hey inflation is here to stay. While negative real yields imply that there are medium or long-term growth concerns. And that really gets to the heart of the issue, which is whether or not the Fed is in the midst of committing a policy error,” said Ian Lyngen, head of US rate strategy at BMO Capital Markets.

Meanwhile, Wall Street stocks ticked up on Friday as investors looked past inflation concerns to focus on strong corporate earnings.

The broad-based S&P 500 index added 0.5 per cent, on track to end the week less than 1 per cent lower after hitting a series of record highs this month. Sentiment was also lifted by Johnson & Johnson, the world’s largest healthcare group, announcing a spin-off of its consumer business.

Elsewhere, the technology-focused Nasdaq Composite index gained 0.8 per cent. Europe’s regional Stoxx 600 closed up 0.3 per cent.

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