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US 10-year Treasury yield on brink of 3%

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The yield on the 10-year Treasury note was on the cusp of 3 per cent for the first time in more than four years on Monday, as concern about inflation returned.

Oil’s move above $70 a barrel and firmer metal prices have fanned worries about inflation, which for much of the post-financial crisis period has remained subdued and helped sustain a rally in bonds.

“Investors are taking the view that the global inflation climate is worsening with the combination of trade friction and sanctions leading to spots of higher prices, for oil, metals and at some stage other goods that are hit with tariffs,” said Koon Chow, strategist at UBP. “This explains the moves for US bonds.”

The prospect of higher inflation dims the appeal of longer-term debt such as 10-year Treasuries, given the threat a higher level of consumer prices poses to their fixed returns. On Monday, the US government 10-year note — a benchmark for mortages and corporate borrowing — rose as high as 2.995 per cent, before falling back to 2.962 in Asia on Tuesday. The yield on the two-year Treasury note was up almost 2bp at 2.48 per cent.

Donald Trump’s election with the promise of economic stimulus catapulted bond yields higher, sending the 10-year yield as high as 2.62 per cent in March 2017. It then came close to touching the 3 per cent level in February this year as the passage of US tax reform late last year helped stir inflationary worries.

Paul Brain, head of fixed income at Newton Investment Management, expects a “consolidation point” of 3.1 per cent to 3.4 per cent for the US 10-year yield.

“This path towards higher yields can be stopped in its tracks if we see a meaningful sell-off in risk assets (such as the early February equity rout), in the absence of which we would expect yields to continue to creep higher,” he said

Oil’s move above $70 a barrel and firmer metal prices have fanned worries about inflation, which for much of the post-financial crisis period has remained subdued and helped sustain a rally in bonds.

“Investors are taking the view that the global inflation climate is worsening with the combination of trade friction and sanctions leading to spots of higher prices, for oil, metals and at some stage other goods that are hit with tariffs,” said Koon Chow, strategist at UBP. “This explains the moves for US bonds.”

The prospect of higher inflation dims the appeal of longer-term debt such as 10-year Treasuries, given the threat a higher level of consumer prices poses to their fixed returns. On Monday, the US government 10-year note — a benchmark for mortages and corporate borrowing — rose as high as 2.995 per cent, before falling back to 2.962 in Asia on Tuesday. The yield on the two-year Treasury note was up almost 2bp at 2.48 per cent.

Donald Trump’s election with the promise of economic stimulus catapulted bond yields higher, sending the 10-year yield as high as 2.62 per cent in March 2017. It then came close to touching the 3 per cent level in February this year as the passage of US tax reform late last year helped stir inflationary worries.

“This path towards higher yields can be stopped in its tracks if we see a meaningful sell-off in risk assets (such as the early February equity rout), in the absence of which we would expect yields to continue to creep higher,” he said

Bond yields in the eurozone and UK were also higher on Monday but 10-year gilt and Bund benchmarks remain below their peaks for the year. Weaker than expected economic data have cast some doubt on the future pace of the European economic recovery, leaving eurozone yields lagging behind the move higher in Treasuries.

“Over the past two months ECB rate hike expectations have corrected lower and [EUROZONE]rates have retreated significantly from their February highs,” said Norbert Aul, a strategist at UBS, who noted that “confidence in an ever-stronger growth momentum has been dented”, resulting in euro yields finding “a floor”.

The path of eurozone bond yields in the coming months “will largely depend on growth and inflation data”, he added, with the market expecting to get an indication from the ECB about future quantitative easing in July.

From the turn of the millennium to 2007, the 10-year US Treasury yield averaged 4.7 per cent, according to Reuters data. But the Federal Reserve’s interventions during the financial crisis, including cutting its benchmark overnight interest rate to essentially zero in 2008, knocked yields lower.

The drop was intensified by the Fed’s decision in 2009 to begin purchasing longer-term Treasuries for the first time under its quantitative easing programme, according to a chronology produced by Yardeni Research. It followed up with two additional QE schemes, and “Operation Twist” in which it extended the average maturity of its portfolio.

Other central banks, notably the European Central Bank and Bank of Japan, have also undertaken bond purchases that have pressured long-term yields globally. In a sign of the intensity of the bond buying, the pool of negative-yielding corporate and government bonds yielding less than 0 per cent rose above $14tn in 2016.

With the US economy expanding steadily since the end of the 2008-2009 recession, the Fed has been at the forefront of policy tightening among central banks. It has halted its bond purchases and increased interest rates six times since the raising cycle began in 2015. – Copyright The Financial Times Limited 2018.

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