T-yields surge as investors eye clues on Fed plans

US Treasury yields surged at the long end on Wednesday after the prior day’s rally as investors awaited greater clarity on the “restrictive” policy the Federal Reserve plans to pursue next week to combat inflation by curbing economic growth.

This week a lot of the price action you’ve seen in bonds has a lot more to do with the volatility. The yield on 10-year Treasury notes was last up 5.2 basis points to 2.824%, rebounding from earlier declines in yields across the curve. Three- and six-month bills were lower, but from two-year notes to 30-year bonds yields were higher.

There was also a feeling that perhaps the market had risen too fast too quickly, as investors anticipate an aggressive Fed as it sets about tackling high inflation. Data showing the US trade deficit in goods widened to a record high in March had little impact on the market, though it likely will add to the slower growth the Fed will cause pursue plans to shrink its $8.9 trillion balance sheet.

Trade has subtracted from gross domestic product growth for six straight quarters, the longest such stretch since the beginning of 2016.

The Fed and other central banks are moving into restrictive territory and could adopt a policy that restricts liquidity by lowering money supply make loans and credit more expensive. But, there’s a misunderstanding about how the policy, also referred to a quantitative tightening, actually works. The Fed will announce further details when policymakers meet May 3-4.

There have been very few experiences in terms of shrinking the balance sheet. Policymakers have only tried it once, and it ended as in the Fed’s 2018 attempt to reduce the balance sheet. The Treasury sold $49 billion in five-year notes at a high yield of 2.785%. The auction was a little bit weaker than expected. The yield on the 30-year Treasury bond was up 4.4 basis points at 2.914%.

A closely watched part of the US Treasury yield curve measuring the gap between yields on two- and 10-year Treasury notes, seen as an indicator of economic expectations, was at 23.3 basis points. The two-year US Treasury yield, which typically moves in step breakeven was up 0.7 basis point at 2.589%.

The breakeven rate on five-year US Treasury Inflation-Protected Securities (TIPS) was last at 3.3%, after closing at 3.274% on Tuesday, down from a more than 17-year peak of 3.639% hit last week.

The 10-year TIPS breakeven rate was last at 2.893%, indicating the market sees inflation averaging about 2.9% a year for the next decade.

The US dollar 5 years forward inflation-linked swap , seen by some as a better gauge of inflation expectations due to possible distortions caused by the Fed’s quantitative easing, was last at 2.632%.