Short-dated Treasury yields, which reflect expectations of where interest rates will be in the future, reached their highest level since March 2020 on Tuesday, as investors bet that inflationary pressures have pulled forward the date of the first US interest rate rise.
The yield on the two-year US Treasury note on Tuesday touched 0.36 per cent, a level not reached since days after the Federal Reserve cut borrowing costs to zero to battle the coronavirus crisis. The five-year note yield reached a high of 1.09 per cent, its highest level since February last year. The yield on the three-year note also reached a 19-month high.
The move came after the price of West Texas Intermediate crude oil hit a seven-year high of more than $82 a barrel on Monday before pulling back to settle at $80.64 on Tuesday. Brent crude, the international oil benchmark traded slightly off Monday’s three-year high to settle at $83.42.
The IMF urged central banks to be “very, very vigilant” about inflation ahead of data on Wednesday that economists expect will show US year-over-year consumer price rises exceeded 5 per cent in September for the fourth consecutive month.
“The market is now definitely pricing in one US rate rise by the end of next year,” said Fahad Kamal, chief investment officer of Kleinwort Hambros.
Expectations of a 0.25 per cent interest rate increase in July next year rose from 21.7 per cent a week ago to 34.9 per cent today, according to CME Group’s FedWatch tool.
Higher energy prices have intensified concerns that price pressures, initially caused by supply chain bottlenecks as industries reopened from Covid-19 shutdowns, will prove more than temporary, and pressure the Fed to raise rates in order to avoid eroding investment returns, corporate profits and consumer spending.
Half the Fed’s rate-setters have already forecast a rate rise next year. The US central bank has also signalled that it is ready to reduce its $120bn a month of pandemic-response bond purchases as soon as November.
“We see a risk that September CPI . . . could be higher than expectations,” Standard Chartered strategists said in a note to clients.
But the Fed’s monetary policy committee was also likely to “debate on how aggressive to be on rates” because of the risk of creating an economic slowdown, they added.
In stock markets, Wall Street’s blue-chip S&P 500 index closed down 0.2 per cent, following a choppy session on Monday where an initial boost for energy stocks faded as questions about economic growth came to the fore. The technology-focused Nasdaq Composite was down 0.1 per cent.
Europe’s Stoxx 600 benchmark was volatile on Tuesday, dropping 1.2 per cent in early dealings to fall about 5 per cent below its all-time high reached in mid-August, before closing the session 0.1 per cent lower. London’s FTSE 100 index closed down 0.2 per cent.
In Asia, China’s CSI 300 fell 1.1 per cent, with the stocks of utilities dropping the most amid an electricity shortage driven by a lack of adequate coal supplies. Tokyo’s Nikkei 225 lost 0.9 per cent as utilities’ shares fell along with highly valued technology stocks that are vulnerable to the prospect of US interest rates rising.
“Markets are clearly worried about inflation and the big concern is the rising oil price and what it will do to earnings, to growth,” said Marija Veitmane, senior strategist at State Street Global Markets. “We don’t think it will go away very quickly.”
Unhedged — Markets, finance and strong opinion
Robert Armstrong dissects the most important market trends and discusses how Wall Street’s best minds respond to them. Sign up here to get the newsletter sent straight to your inbox every weekday