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Global bonds buckle as investors wary ahead of Fed

The prospect of a more aggressive Federal Reserve and a surge in the oil price hit global bonds on Monday, sending the yield on the benchmark 10-year Treasury note above 2.5 per cent for the first time since 2014.

Treasuries have led a sharp sell-off in sovereign bonds since Donald Trump’s victory in last month’s US election, raising the prospect that Fed officials will have to raise interest rates more quickly than expected to ward off inflation.

The bounce in US government yields was echoed across European markets, with the yield on the 10-year German Bund touching its highest level since January, as investors square up a likely rate rise from Fed officials this week and the possibility they project a more aggressive tightening cycle next year.

“Whether he (Trump) can deliver or not does not really matter yet because it is the risk that he can that is driving things,” according to Chris Iggo, chief investment officer of fixed income at Axa Investment Management. “If he provides a fiscal boost to an economy that is already operating at full capacity then the likelihood is that inflation and interest rates will be higher. The risk of dis-believe was too great given the asymmetric return outlook for a bond market already operating with yields close to all-time lows.”

The sharp turn in sentiment towards sovereign bonds was underlined by fresh data from the Commodity Futures Trading Commission on speculative positions, which show the biggest bets against a rise in 10-year Treasury prices since the start of 2015.

US policymakers are widely expected to raise the overnight Fed funds rate on Wednesday by 25 basis points to a 0.50-0.75 per cent target range, which on Monday helped push the two-year note — especially sensitive to changes in the Fed funds rate — to 1.15 per cent. That is near its highest level since April 2010.

Concern that the current level of yields is not reflecting the risk of faster growth and inflation was deepened as the oil price hit a new high for the year on Monday. Up 4.6 per cent to almost $57 a barrel, Brent crude was handed greater impetus after Saturday’s agreement by producers outside the Opec cartel to cut production.

The agreement has “also prompted a further rise in G7 bond yields, which remain low relative to the prospect of larger swing from deflation to inflation in energy prices pushing up CPI to levels where real yields on conventional govt bonds would look very meagre”, said Marc Ostwald, a strategist at Admisi.

On Wednesday, there will be particular focus on the Fed’s new “dot plot” — a map of where individual officials project the Fed funds rate will be in the next three years. It “could give us a first look at FOMC members’ true thoughts on whether they feel that the fiscal policy initiatives announced by the new US administration will boost the economy in 2017 or whether they have concerns about the adverse impact of trade policies on the US economy”, said Richard McGuire at Rabobank.

Since Mr Trump’s election, investors have pushed US equities to record highs as they anticipate increased government spending and tax cuts designed to lift the economy’s annual growth rate to 4 per cent.

Eurozone sovereign bond yields were at their highest levels since the start of the year, with French debt particularly out of favour. French borrowing costs were edging up as investors demand a higher premium for holding bonds of the eurozone’s second-largest economy ahead of the presidential election next year.

Peripheral eurozone debt was also under pressure, with Portuguese 10-year yields eyeing 4 per cent, while the Italian benchmark approached peaks previously seen in July 2015. In the UK, the benchmark 10-year gilt yield climbed to 1.5 per cent early on Monday for the first time since the country’s Brexit vote in late June.

The Bank of England is meeting for its latest policy decision this week but is not expected to make any change to its record low policy rate or shift the parameters of its rebooted quantitative easing measures on the back of encouraging data on the state of UK growth after the Brexit vote.

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