US government bonds fell sharply on Wednesday after the Labor Department reported that consumer prices rose last month, escalating concerns that the Federal Reserve will need to act more forcefully to slow inflation.
Yields on two-year Treasury notes, which are highly sensitive to interest rate expectations, have risen the most since the market turmoil caused by the coronavirus outbreak in March 2020. The yield rose 0.09 percentage points to 0.52 percent, indicating a significant price drop. The five-year note gained the most ground, rising 0.14 percentage points to 1.22 percent.
Bonds with shorter maturities rose in price last week after Fed Chair Jay Powell pledged to be "patient" in raising interest rates, citing expectations that such high inflation levels would be transitory. However, data released on Wednesday showing that US consumer prices rose 6.2 percent in October compared to the same month in 2020, far exceeding expectations of 5.8 percent, cast doubt on that pledge.
“I don’t see how the Fed can afford to wait,” said Tom Graff, head of fixed income at Brown Advisory. “The pressure is getting awfully high for some sort of response,” Graff said that if inflation continued at this rate, the central bank might be forced to accelerate its quantitative tightening so that it ends this winter.
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Eurodollar futures, a closely watched indicator of market expectations of Fed policy, revealed that investors were pricing in a 75% chance of a rate hike as soon as June 2022. Traders were also anticipating at least two quarter-point rate hikes by the end of next year.
According to Bloomberg data, the 5-year break-even inflation rate, which reflects where investor jobs expect inflation to be in five years, increased to 3.1 percent, the highest level since records began in 2002.
Longer-dated Treasuries, which provide a snapshot of investor expectations for future economic growth and inflation, experienced a more measured sell-off at first. However, yields rose following a lackluster auction for new 30-year bond issues.
To meet soft demand, the government sold $25 billion in 30-year debt at midday on Wednesday. This was immediately followed by a sell-off in secondary markets, pushing the long bond yield to a high of 1.96 percent. Later in the afternoon in New York, the move had slowed, but the yield remained 0.10 percentage points higher on the day at 1.91 percent.
The dollar index, which compares the US currency to six others, increased by 1%. Global concerns about inflation were heightened earlier on Wednesday by data showing that Chinese producer price inflation — the measure of what businesses pay each other for goods — rose 13.5 percent in October from the same time last year, the largest increase in 26 years factory jobs absorbed higher energy prices.
Fears of rising prices have gripped the bond markets of the United Kingdom and Canada, where central bankers have signaled a willingness to intervene to combat price rises. The two-year gilt yield in the United Kingdom increased by 0.12 percentage points to 0.55 percent. The equivalent Canadian bond yield increased by 0.08 percentage points to reach 1%. Brent crude, the oil benchmark, fell 2.5% to $82.64 per barrel.
