Analysis: ‘More damage to do’ as sizzling inflation sees Treasury yields rise


Plastic letters arranged to read ‘Inflation’ are placed on a US dollar banknote in this illustration taken June 12, 2022. REUTERS/Dado Ruvic/Illustration

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NEW YORK, Sept 14 (Reuters) – Expectations of a more hawkish Federal Reserve are prompting some investors to reconsider the extent of rising bond yields, a potentially unwelcome development for equity and fixed-income markets already in trouble.

The two-year US Treasury yield, a gauge of interest rate expectations, stood at 3.79% on Wednesday, putting it near its highest level since November 2007 as the market recalibrates expectations about how aggressively the Fed will raise rates in its effort to tame inflation.

Some fund managers now believe the uptrend will continue, with yields on two-year Treasuries rising above 4% to new 15-year highs.

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“There’s no getting around it,” said Ed Al-Hussainy, senior global rates strategist at Columbia Threadneedle. “You need to see more weakness in the labor market before building even a little confidence that rates have peaked and there isn’t enough at all right now.”

Rising bond yields have increased pressure on equities this year, particularly growth and technology stocks, as they threaten to erode the value of future corporate earnings and raise the cost of capital. Read more

The S&P 500’s technology sector (.SPLRCT) has fallen more than 12% since mid-August, compared to an 8.3% decline for the broader S&P 500 over that period. The S&P 500 is down 17% this year.

Al-Hussainy says he expects stocks and bonds to continue falling as rising costs weigh on consumers and businesses and the economy eventually slides into a recession. Bonds will then likely stabilize, while equities and other risky assets could see further declines, he said.

“There is more damage to do,” he said.

‘GAME EXTENDER’

Consumer prices edged up 0.1% last month and rose 8.3% over the past 12 months, well above Wall Street expectations and the 2% annual target of the Fed, according to data released Tuesday.

Markets are now pricing in a 30% chance that the Federal Reserve will raise benchmark interest rates by 100 basis points at its meeting that ends Sept. 21, up from 0% before the inflation data was released. Some analysts have also predicted larger rate hikes in the coming months. learn more / FEDWATCH

Expectations for higher returns were on the rise even before Tuesday’s data. A Deutsche Bank survey earlier this week showed that 73% of investors believe risks are more biased by the 10-year Treasury yield hitting 5% rather than 1%. This compares to 60% in June. The 10-year yield was recently around 3.41%.

“If the 10-year yield hits a new year-to-date high above 3.5%… then the long-term chart and talks on a 10-year 4% will continue to come back to the front of the scene,” Paul Ciana, chief technical strategist for FICC at Bank of America Merrill Lynch, wrote in a note Wednesday.

Jake Schurmeier, portfolio manager at Harbor Capital, said Tuesday’s inflation data “certainly” raises the risk that short-term Treasury yields will top 4% by the end of the year.

“The underlying risk is that inflation in the services sector could represent stronger growth than the Fed expected, forcing it to act even more aggressively,” he said.

He now expects the Fed to raise rates an additional 175 basis points through the end of the year, then raise them another two to three times in 2023 until the economy falls into recession. , did he declare.

Still, the growing likelihood of a recession may mean that any spike in Treasury yields is likely to be short-lived and return as investors position themselves more defensively by buying bonds, said Ian Lyngen, head of the US rates strategy at BMO Capital Markets Fixed Income. Strategy team.

“It’s tempting to conclude that yesterday’s CPI report was a game-changer for the Fed,” he said. “However, it is more aptly characterized as a game extender.”

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Reporting by David Randall, editing by Ira Iosebashvili and Deepa Babington

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