US Treasuries sell-off continues on inflation fear

The US government bond market suffered a renewed sell-off and the dollar powered to a fresh 13-year high on Wednesday, as stronger economic data bolstered the case for an interest-rate increase and reinforced the view that the multi-decade bond bull market has reached a turning point.

The Republican sweep of the White House and Congress, coupled with president-elect Donald Trump’s promise to unleash a $1tn economic stimulus package of tax cuts and infrastructure investments, has caused a seismic shift in global bond markets, with prices tumbling and borrowing costs rising as investors bet that inflation will finally reappear.

European bond yields had already jumped earlier on Wednesday on the back of reports that the European Central Bank was considering changes to its securities lending programme, which would ease a bond shortage. The moves were reinforced by strong US durable goods data, and exacerbated by thin trading in bond markets ahead of the US Thanksgiving holiday.

“In what was supposed to be a quiet day, bond vigilantes are putting it to the Treasury market,” said Andrew Brenner, head of international fixed income at National Alliance Capital Markets.

The US government debt market staged an afternoon comeback, clawing back some of its earlier losses, but still ended the day in the red.

The 10-year Treasury yield at one point climbed by much as 10 basis points to over 2.4 per cent for the first time since the summer of 2015, and ended the day 4bp higher at 2.35 per cent. The two-year note yield, the one most acutely sensitive to interest rate expectations, climbed to a six-year high of 1.15 per cent.

The moves came after the US Commerce Department said that orders for durable goods had risen by 4.8 per cent in October, smashing economists’ expectations and reinforcing the sense that any stimulus package will come at a time when the economy is already in reasonable shape, and therefore fuel inflation.

“Donald Trump’s surprise election victory should be viewed as a new global shock, mixing positive demand and negative supply elements. There remains considerable uncertainty about the actual mix of policies to be enacted but the bias of risk reinforces the tilt toward reflation,” JPMorgan’s analysts said in a note.

Adding to the conviction that interest rate increases are on the cards, minutes from the Federal Reserve’s meeting on November 2 indicated that officials thought the central bank should act “relatively soon”, even before a run of decent economic data and Mr Trump’s election win.

As a result, mounting expectations of more aggressive US interest rate increases in the coming year has reawakened the slumbering dollar rally, sending the DXY index of the currency’s strength against its major peers to a fresh 13-year high on Wednesday. Only two of the world’s top currencies managed to hold their ground against the greenback.

The yen led a retreat, while the gap between US and Japanese yields widened, opening up the prospect of the Bank of Japan having to intervene in the bond market to retain credibility.

With yields in other bond markets rising in tandem with Treasuries, analysts believe it is getting tougher for the BoJ to maintain its policy of “yield curve control”, keeping the yield on 10-year Japanese government bonds at zero.

The weakening yen was “not a bad thing” for Japan, said Alan Ruskin, a currency strategist at Deutsche Bank, but the widening yield spread was “a problem from a credibility standpoint”.

The jump in Treasury yields also reverberated through the US stock market, the day after all four of the country’s main equity indices hit a new record on the same day for the first time since 1999.

Industries that are considered safer and nearly “bond-like”, such as real estate trusts and utilities, were hit hard on Wednesday. Financial stocks, which benefit from rising interest rates, and smaller companies, that are shielded from the impact of a stronger dollar, rose to fresh records.