The path to higher Treasury yields has been opened, and traders believe it is inevitable that the Fed will start normalizing monetary policy next month as the economy improves and the threat of inflation intensifies.
The yield on 10-year Treasuries broke through the key level of 1.6 per cent on Friday, entering a range of interest rates that are thought to trigger a sell-off in mortgage-related Treasuries. The benchmark yield has risen for seven consecutive weeks, and holders of bonds of that maturity or longer have lost more than 8% this year, according to the Bloomberg index.
Even the lower-than-expected non-farm payrolls data for September failed to remove the pressure on the Fed to act because it was accompanied by strong wage growth. These figures, coupled with the backdrop of soaring energy prices, make investors wonder whether inflation will be as temporary as many Fed policy makers insist.
Although there are still nearly four weeks to go before the Fed's next policy meeting, the minutes released on Wednesday are likely to provide more clues about what officials think. Consumer prices have risen more than 5% year-on-year for four months in a row, and the latest developments have attracted the attention of investors. An indicator of inflation expectations in the bond market, which has fluctuated narrowly for months, rose last week to its highest level since May.
"these inflationary pressures that are widespread around the world are now the focus," said Gregory Faranello, head of US interest rates at AmeriVet Securities in New York. "the Fed has always stressed that they will not raise interest rates until the reduction is completed, so they need to continue to reduce the weight. If they don't, then at some point the market may challenge the Fed-pushing up yields. "
The yield on the 10-year Treasury note has now risen to about 1.6 per cent from less than 1 per cent at the start of the year, while the Faranello expects it to close between 1.75 per cent and 2.25 per cent in 2021.
The Fed currently buys $120 billion of bonds a month, of which $80 billion is in Treasuries and $40 billion is in mortgage-backed securities. Anastasia Amoroso, chief investment strategist at iCapital Network, agrees that the employment situation is enough for the Fed to start downsizing.
The 10-year break-even inflation rate hit 2.51% last week, the highest level in nearly five months. Meanwhile, the 30-year break-even yield rose to 2.38 per cent on Friday, up from 2 per cent at the end of last year.