US Treasurys have taken a hit from the Fed’s hawkish tone, but investors are a lot less worried about inflation in the long run

Bull and Bear sculptures outside the Frankfurt Stock Exchange in Frankfurt,
Bull and Bear sculptures outside the Frankfurt Stock Exchange in Frankfurt,

  • The Federal Reserve has shifted its outlook for interest rates and inflation and short-dated bonds have taken a hit.
  • The Fed’s predictions have hurt global equities and lifted shorter-term Treasury note yields.
  • Longer-dated yields have fallen sharply, showing investors are not worried about a sustained pickup in inflation.
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The US Treasury market is showing investors are preparing for a faster pickup in inflation and borrowing rates, after the Federal Reserve indicated last week it could raise interest rates sooner than previously expected, but they don’t expect that to last.

When the Fed said after its monetary policy meeting that it could raise rates by the end of 2023 in response to more robust economic growth and inflation, global equities sold off, along with other interest-rate sensitive assets such as commodities, and short-term Treasurys in particular, sending 2-year yields to their highest in well over a year.

But that same hawkishness has not played out across the whole of the Treasury market. Since Wednesday last week, the yield on the 30-year US Treasury bond has dropped by around 20 basis points to its lowest since February, reflecting a belief among investors that the Fed will likely be successful in warding off a damaging inflationary spike.

It was last at 2.064% at 9.23 am E.T. on Monday.

In contrast, yield on the two-year Treasury note has risen by around 13.5 basis points since the Fed’s announcement, bringing yield up to 0.27% as of the early hours of US trading on Monday – its highest since January. This has brought the gap, or spread, between 2-year and 30-year yields to its narrowest since February.

St Louis regional Fed President James Bullard added fuel to the trade. He said in an interview on Friday the central bank could even raise rates by the end of next year. He also confirmed the Fed was discussing winding down its asset-purchase program.

The two-year Treasury note is the most sensitive to shifts in interest rate expectations and Bullard’s comments prompted the yield to almost double at one point in the day on Friday, before subsiding somewhat.

The steeper drop in yields on longer-term Treasurys, however, indicates investors believe the Fed will be likely be successful in tempering inflation and that they do not believe markets will experience a series of aggressive rate increases in the long-term. Instead they seem to expect a slowdown in economic growth, coupled with low levels of inflation in the long-term – even if inflation levels should rise sharply in the immediate future, analysts said.

Equities at least could be for more pain, at least in the short term, according to Jeffrey Halley, senior market analyst at OANDA. “If it continues, we may see an overdue reckoning for some of the dumber investment decisions being made by investors searching for yield in a zero per cent world-high yield credit and SPACs for a start.” he said.

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Global stocks tumble, gold slides after the Fed signaled it could hike rates sooner than expected

trader nyse worried chart

Global stocks slid on Thursday morning, as gold prices sank and the dollar strengthened, after the Federal Reserve signaled a rise in US interest rates could come sooner than expected.

US stock futures pointed to a lower open ahead, following losses for the major indexes in the wake of the news. Dow Jones futures were last down 0.46% at 4.55 a.m. E.T., while S&P 500 futures dipped 0.49%, and Nasdaq futures fell 0.69%.

The FOMC’s latest outlook showed more Fed officials are expecting interest-rate rises in 2023, when at its last meeting, no hikes were projected until after that year. Markets interpreted this as a sign the US central bank might be open to letting inflation heat up to help the US economy recover from the pandemic.

“While not a full turn away from ‘transitory’, it was a clear signal that the Fed is open to the idea that some aspects of the recent price increases can be more permanent,” Jim Reid, research strategist at Deutsche Bank, said in a note.

“This was as hawkish as they could have possibly gone at this stage within realistic expectations,” he said.

Also seen as important was that for the first time, Fed officials discussed tapering, or slowing down, its multi-trillion-dollar asset-purchase program, brought in to help the financial system during the COVID-19 crisis.

Yields on the five-year Treasury note, which are highly sensitive to switches in Fed policy, logged the most volatility. The yield jumped to as much as 0.91% from 0.78% immediately before the announcement and closed the day with an 11-basis point increase. By Thursday, it was holding steady around 0.886%.

The US dollar moved higher, while gold prices stumbled by almost 3% on Thursday morning. The metal was last down 2.4%, trading at $1,806.83 an ounce.

“The Treasury and foreign-exchange markets were the main drivers against gold prices following the FOMC decision,” said Thomas Westwater, an analyst at DailyFX. “Given the large drop, bulls may need to wait for more hands to shake out before attempting to make a decisive move higher. That said, price may consolidate in the coming days before the next directional move.”

Oil prices steadied on Thursday, broadly flat after Brent crude broke a five-day rally on Wednesday. Brent was last down 0.03%, trading at 74.37 per barrel, while WTI was unchanged, trading at $72.15 per barrel.

European stock markets followed their US counterparts lower. Frankfurt’s DAX was last down 0.09%, the FTSE 100 in London slipped by 0.51%, and the Euro Stoxx 50 fell by 0.18%.

Asian markets closed out another mixed session. The Japanese Nikkei 225 lost 0.93% while Hong Kong’s Hang Seng index gained 0.19% and China’s Shanghai Composite, which fell earlier in the week on the back of political tensions between China and NATO, regained strength and inched 0.21% higher.

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European Central Bank holds interest rates and bond-buying steady as it weighs up the eurozone’s recovery

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Christine Lagarde is the president of the European Central Bank.

The European Central Bank kept interest rates at record-low levels on Thursday and kept its enormous bond-buying program steady as it weighed up the recovery in the eurozone economy.

The ECB’s main deposit rate will stay at -0.5%, while the coronavirus bond-buying package will stay at 1.85 trillion euros ($2.23 trillion), the governing council said in a statement.

At the bank’s last meeting it pledged to step up the pace of bond purchases in response to rising bond yields.

COVID-19 battered the eurozone economy in 2020, and a resurgence of cases has led many countries to reimpose tough restrictions in 2021.

But policymakers and citizens see hope on the horizon. The European Union’s initially slow coronavirus vaccine rollout is picking up pace and the International Monetary Fund has upgraded its growth forecast for the eurozone in 2021 to 4.4%, after the economy shrank 6.6% in 2020.

The European Central Bank’s decision to hold interest rates came as no surprise to analysts.

“Vaccination numbers within the euro area are beginning to pick up pace, providing hope that economies will soon be able to start the reopening process,” Mohammed Kazmi, portfolio manager for Swiss private bank UBP, said.

He added: “We think it makes sense for investors to start preparing and positioning for the June ECB meeting, which will likely be accompanied by significant growth revisions higher and [bond] purchases for Q3 probably moving back towards a more normal pace.”

The euro was around 0.1% higher against the dollar on Thursday at $1.204, while the yield on the key German 10-year government bond had risen 0.9 basis points to -0.250%.

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Biden breaks with Trump and says he’ll stick up for Federal Reserve’s independence

Trump Biden
  • Biden said he wanted to break with Trump in sticking up for the Federal Reserve’s independence.
  • “I want to be real clear that I’m not going to do the kinds of things that have been done in the last administration,” Biden said.
  • While he was in office, Trump pressured Fed Chair Powell against raising interest rates.
  • See more stories on Insider’s business page.

President Joe Biden said on Tuesday he would safeguard the independence of the Federal Reserve, breaking with his predecessor, Donald Trump, who often tried pressuring the central bank to lower the cost of borrowing.

“Starting off my presidency, I want to be real clear that I’m not going to do the kinds of things that have been done in the last administration – either talking to the attorney general about who he’s going to prosecute or not prosecute … or for the Fed, telling them what they should and shouldn’t do,” he said at a White House news conference.

“I think the Federal Reserve is an independent operation,” he said, adding he does speak with Treasury Secretary Janet Yellen. The Treasury did not immediately respond to a request for comment.

The remarks reflect another way that the president is distancing himself from his predecessor by preserving the Fed’s traditional independence from the White House. Trump heaped criticism onto Powell throughout his term, assailing him as “an enemy of the state” and a “terrible communicator” from his now-suspended Twitter account.

Trump furiously tried pressuring Powell from raising interest rates while the economy was in the middle of its longest expansion in history in the years leading up to the pandemic. At one point, he suggested Powell may be a “bigger enemy” of the US than China.

Powell played a critical role designing the Fed’s stimulus programs as vast swaths of the economy shut down last year. He also encouraged Congress to continue approving more federal aid for struggling individuals, small businesses, and state and local governments.

“Given the low level of interest rates, there’s no issue about the United States being able to service its debt at this time or in the foreseeable future,” he told NPR recently. Powell, a Trump nominee, has also downplayed the inflation risks stemming from the $1.9 trillion stimulus package.

Powell’s term as Fed chair expires in 2022, and Biden must decide whether to keep him onboard.

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