With investors getting rid of the highest inflation rate since 2008 and pouring into government bonds, U.S. Treasury bonds will enter their best week in a year on Friday afternoon.
The benchmark 10-year U.S. Treasury bond yield fell 0.09 percentage points to 1.47%, the largest weekly decline since June last year.
This move was driven by the decline in inflation expectations. The 10-year breakeven inflation rate dropped 0.08 percentage points to 2.36% this week.
Although data on Thursday showed that US consumer prices jumped to 5% year-on-year in June, a cooling in long-term inflation expectations has occurred.
This shows that investors are increasingly willing to accept the Fed’s mantra that higher inflation will prove to be short-lived and will stabilize once the comparison with last year’s lock-in economy ends.
The 10-year U.S. Treasury bond yield fell by 0.06 percentage points on Thursday and fell by 0.03 percentage points on Friday.
In the past month, the world’s largest government bond market has undergone drastic changes. In early May, 10-year inflation expectations hit the highest level since 2013, and the 10-year US Treasury bond yield was 1.70%. Many fund managers have bet that the Fed will have to quickly reduce monetary stimulus measures, reducing the current US Treasury bonds and government-backed mortgage loans of up to $120 billion a month to deal with the surge in inflation.
“Last month, people saw inflation picking up and they thought it was impossible for the central bank to stand by and do nothing,” said Andrea Iannelli, Fidelity International Investment Director. “But investors are realizing that this is actually what they are going to do.”
Analysts said the recent rebound was further driven by short-squeeze because investors who had bet on US Treasuries earlier this year were forced to admit defeat when the market turned against them.
Ian Lyngen, head of US interest rate strategy at BMO Capital Markets, said that despite buying this week, many investors still hold short positions, indicating that the squeeze may continue and yields may fall further.
A customer survey conducted by BMO last week found that a record 71% of investors believe that the next major change in U.S. Treasury yields will be an increase. “We have raised various questions about’How long will the current distortion last?'” Lingen said.
Others expect that this week’s U.S. Treasury bond rebound will prove to be short-lived, while inflation will not.
Oliver Jones of Capital Economics said that in this environment, the Fed will soon have to start softening the market to slow down the bond purchase process, possibly as early as next week’s meeting.
He said that the recent rebound “may be just a respite after a historic rapid sell-off in the first quarter of this year.” “We doubt it will continue.”
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