Investors sold US government bonds for a second day on Wednesday as they weighed the spectre of inflation picking up next year if an economic stimulus package is agreed in Congress.
Yields on 10-year Treasury notes, which move inversely to prices, rose 0.02 percentage points to 0.94 per cent. Yields had gone up 0.09 percentage points on Tuesday as inflation expectations rose. A month ago yields on the 10-year note were around 0.76 per cent.
The sell-off stood in contrast to the moves in shorter-dated notes, which have been mostly anchored as the Federal Reserve has hoovered up US government debt. The difference in yield between the two and 10-year Treasury notes rose to 78 basis points by the end of the US trading day on Wednesday, its highest level since October 2017.
The moves came as Democratic congressional leaders expressed support for a $908bn spending plan offered by a bipartisan group of US senators, in a compromise aimed at breaking the logjam that has prevented more aid from being delivered to Americans during the coronavirus pandemic.
The effort to bring fiscal aid over the finish line could be “a catalyst for change in the [Treasury] market’s psyche”, which had been more pessimistic on “where things are” than the stock market, said James Knightley, chief international economist at ING, noting that the size of the proposed package is about 4 per cent of US gross domestic product.
The deal “offered support for those of us saying the Covid crisis is more likely to lead to inflation than deflation”, said Jim Reid of Deutsche Bank.
Inflation expectations for the US, as measured by prices of inflation-protected government securities, have this week risen to an 18-month high of 1.83 per cent.
Bond investors fear rising inflation as this erodes the value of the fixed-interest payments on securities. In turn, rising bond yields prompt equity investors to query what they should be paying for stocks.
The S&P 500 rose 0.2 per cent on Wednesday, setting a new closing record. The tech-focused Nasdaq Composite dropped by less than 0.1 per cent.
The rotation that lifted economically sensitive stocks in November after they had been “left behind” during the pandemic is set to continue, said Susan Schmidt, head of US equities at Aviva Investors, noting the Nasdaq’s outperformance over other major US indexes in 2020 remains significant.
“There is a lot of confidence things are going to get better”, which will contribute to narrowing the valuation disparity, she said.
Equities have rallied through the pandemic as the US Federal Reserve has bought Treasuries at an unprecedented rate, pushing real rates of income on the securities, which account for the effects of inflation, below zero and increasing the attractiveness of other financial assets. This year tech stocks have been particularly sensitive to changes in bond yields.
Salman Ahmed, head of global macro at Fidelity International, said the Fed was likely to “lean against” real bond yields turning positive by continuing to pursue a highly accommodative monetary policy. US Treasury yields influence borrowing costs across the globe and the Fed was “mindful”, he said, of the record amounts of debt that companies and governments have built up during the pandemic.
Esty Dwek, head of global market strategy at Natixis, said it was likely the US government would spend between $500m and $1tn in the first quarter of next year on stimulus schemes such as extending emergency unemployment relief and supporting airlines.
A $1tn package, she said, would “plug holes” in people’s incomes and keep small businesses going but was not enough for inflation to overshoot the Fed’s target of an average of 2 per cent over time or become a significant problem for bond investors. The core measure of inflation favoured by the Fed currently sits at 1.4 per cent.
In Europe the Stoxx 600 closed the session unchanged, having built on its record monthly gain in November the day before. London’s FTSE 100 was an outlier, rising 1.2 per cent after the UK became the first country to approve Pfizer and BioNtech’s coronavirus vaccine.
The dollar dropped 0.2 per cent against a basket of major currencies in afternoon trading on Wednesday, after experiencing a shortlived rebound earlier in the session.
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