Short-term Treasuries hit after higher than expected inflation data

Short-dated US government bonds came under pressure and stocks resumed their recent slide on Wednesday after unexpectedly hot “core” inflation data heightened expectations for aggressive policy tightening by the Federal Reserve.

The yield on the two-year Treasury note, which is particularly sensitive to monetary policy, rose 0.03 percentage points to 2.64 per cent, from below 0.2 per cent a year ago. Yields rise when prices fall.

In contrast, the 10-year Treasury yield, which is driven by longer-term economic trends, shed 0.07 percentage points to 2.93 per cent.

Consumer prices in the world’s largest economy rose at an annual rate of 8.3 per cent in April, down from 8.5 per cent in March but still at a historically elevated level. The figure still exceeded economists’ expectations for a cool-down to 8.1 per cent. The month-on-month change in core inflation, which excludes food and energy prices and is closely watched by economists, also widely exceeded forecasts at 0.6 per cent.

Rising costs of new cars, food, airline fares and housing were the biggest drivers of the increase in consumer prices, the labour department said.

“The report should be of concern for the Fed given price gains in the core segment appear to be spreading,” TD Securities said in a note to clients.

Line chart of 2-year government yields (%) showing US Treasuries sell off after hotter than expected inflation reading

As consumer prices have surged, traders expect the Fed to raise interest rates aggressively for the rest of this year, something that has placed short-term US government debt under particular pressure.

“Today’s report will strengthen the Fed’s resolve to tighten aggressively at its coming meetings, crystallising expectations of [half percentage point] hikes in June and July,” said Silvia Dall’Angelo, senior economist at Federated Hermes.

Futures markets show investors expect the Fed’s main interest rate, currently set at between 0.75 per cent and 1 per cent, to reach 2.8 per cent by the end of this year. Investors strengthened their bets on the pace of rate rises after Wednesday’s inflation data, though the expected end-of- year rate remained slightly below the peak hit last week.

Wall Street stocks reversed course after an early rise, as investors maintained their recent habit of treating any brief rallies as selling opportunities.

The blue-chip S&P 500 share index rose as much as 1.2 per cent on Wednesday morning but had declined 1.3 per cent by mid-afternoon. The tech-focused Nasdaq Composite, which has lost around a quarter of its value so far this year as higher interest rates compressed growth companies’ valuations, dropped 2.7 per cent.

European stocks and US equity futures had rallied before the inflation report as investors assumed that price rises would have shown more signs of peaking as higher energy costs, driven by Russia’s invasion of Ukraine, depressed consumer spending.

“There was a sense that people were cutting back on spending in order to fill up their gas tanks and heat their homes,” said Brian Nick, chief investment strategist at Nuveen. “That clearly wasn’t the case last month.” 

Investors and analysts on Wednesday cautioned that even if inflation had now peaked, it could remain elevated for some time, pushing central banks to continue raising borrowing costs. The Fed, which raised its main interest rate by 0.5 percentage points last week and signalled more hikes to come, targets an average inflation rate of 2 per cent over time.

“It is not just about inflation peaking, but also the trajectory going forward,” said Aneeka Gupta, research director at exchange traded fund provider WisdomTree. “We believe it is going to be a long, drawn-out process back to levels where central banks are comfortable.”

Elsewhere in markets, Europe’s Stoxx 600 share index rose 1.7 per cent. Brent crude, the international oil marker, added 5.1 per cent to $107.73 a barrel.

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