At a time when U.S. inflation is soaring at its fastest pace in 40 years, the Fed's expectations of a rate hike have once again sparked market volatility.
Inflation concerns pushed Treasury yields to two-year highs.
Treasury yields soared
As of Friday's close, benchmark 10-year Treasury yields climbed to 1.788 percent, near their highest closing level since January 2020, erasing earlier losses earlier in the week; 2-year Treasury yields jumped to 0.97 percent, the highest level since February 2020.
U.S. retail sales in December were much lower than market expectations, at a new low since February.
Although this briefly supported the bond market earlier in the day, the bond market subsequently turned bearish.
Fed Chairman Jerome Powell said this week that the Fed is prepared to accelerate the pace of tightening monetary policy if necessary, and some officials have been urging the Fed to do so.
The Fed's statement is cited as reason for the rising yields on 10-year Treasuries, a pattern that often occurs in mid-2019.
Garry Evans, chief global asset allocation strategist at BCA Research, has been expecting the Fed to raise rates three times this year, 25 basis points each, with the possibility of a fourth, according to Bloomberg, playing down the risk of speeding up the tightening cycle. But he said the "wage-price spiral" could prompt the Fed to take a more aggressive approach.
Evans said:
There's a risk that wages will go higher and the Fed is starting to worry. After that, the market began to price the Fed's loss of control over inflation.
JPMorgan Chase CEO Jamie Dimon told analysts on Friday that he expected the Fed's rate hike to exceed markets' current expectations and said the rate hike might not be as "sweet and dovish" as some had expected, Bloomberg reported.
Ian Lyngen, head of U.S. interest rate strategy at BMO Capital Markets, said us Treasury yields edged higher in the late end of the week, also indicating that investors were collectively reluctant to accept the consolidation, but only gained a respite after the pressure to over-sell, "The U.S. Treasury market continues to use inflation as a reason to push yields higher." ”
The moves reflect widespread belief that the Fed will start raising interest rates in March and begin to shrink its $8.8 trillion balance sheet in the second half of the year. The result of the balance sheet reduction will be the refusal of monetary authorities to extend the maturity of upcoming securities, which creates considerable uncertainty in the US Treasury market and will mark a more rapid drawdown of funds than the Fed in the previous tightening cycle.
Investors are flocking to safe havens for inflation-resistant assets
According to the U.S. Treasury Department, the U.S. government sold $1.07 billion in Series I Bonds in November and $2.78 billion in December.
Series I bonds are interest-bearing bonds issued by the U.S. government designed to protect everyone from inflation. Such bonds pay coupons at a fixed interest rate plus an inflation rate.
As consumer prices soar across the U.S., U.S. savers have poured in to buy these inflation-preserved savings bonds, making December more than any previous year's annual purchases.
Full-year issuance of Series I bonds in 2018 was $1.76 billion, while December issued $1 billion more than in all-year 2018, when soaring oil prices pushed inflation to 3 percent. But due to strong consumer demand and supply chain disruption caused by the pandemic, inflation is now at 7 percent, the highest level in 40 years.
The U.S. government began offering Series I bonds in 1998. Since May 2020, the fixed interest rate set for the issuance of these new bonds every six months has been 0%. But that doesn't stop buyers, as the inflation-related interest rates on such bonds are also reset twice a year, and the current rate paid is 7.12 percent per annum.
In fact, the U.S. government has set a hard cap on buying these securities — only $10,000 per person per year — or demand could increase even more.
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