The bond market’s strongest indicators of long-term inflation plunged last week to their lowest level in nearly two years, suggesting to investors that the Fed will bring inflation back close to its target level by raising rates and slowing the economy.
Five- and 10-year break-even inflation rates, which reflect the difference in yield between US Treasury inflation-protected securities (TIPS) and US Treasuries, fell to their lowest since February 2021 , when inflation expectations moderated as the economy recovered from the pandemic stalled and the Federal Reserve downplayed the risk of runaway inflation.
Gennadiy Goldberg, senior rates strategist at TD Securities, New York, said niche funds appeared to be behind some of the selling of TIPS, which boosted the real yields of such securities relative to the nominal yields of bonds. of the Treasury.
Friday’s low for the five-year BEI index was 2.125%, suggesting inflation will average above 2% over the next five years. It was around 2.25% last time. The Fed has been tightening interest rates aggressively since March to control runaway inflation and bring it back to its 2% target.
“The market is confident in the ability of the Fed,” said Jim Barnes, director of fixed income at Bryn Mawr Trust in Berwyn, Pennsylvania. “Even if you see short-term interest rates go up a bit, this tighter policy is having a dampening effect on inflation going forward. But also some of it was just the selling off of risky assets.
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The heightened risk sensitivity has come as major central banks raise rates and UK and European bond markets react to their own inflation and growth issues and, in the case of the UK, announce measures badly received taxes.
Bond markets in major economies have recently experienced almost unprecedented illiquidity and volatility, which may have exacerbated movements in the many fixed income sectors, including BEIs.
The 10-year BEI fell to around 2.115 on Friday and rallied to 2.23% on Monday. One week, the 10-year BEI was playing with 2.5%.
On Thursday, the 10-year BEI fell 14 basis points, its biggest drop since March 2020, when the COVID-19 virus sent markets into a tailspin.
“You’ve also seen outflows of mutual funds dedicated to inflation-protected products,” Goldberg said. “That may be behind some of these moves down breakevens as many investors are starting to exit a very popular position that has been building up over the last year.”
Source: Reuters (additional reporting by Chuck Mikolajczak; editing by David Gregorio)