Treasuries slide as inflation fears eat away at May rally

TREASURIES slumped as renewed inflation fears partially unwound a rally that has put the securities on course for their first monthly gain since November.

US sovereign yields climbed across the curve as oil rose to a 2-month high and European inflation data for May exceeded economists’ forecasts. Hawkish comments from Federal Reserve Governor Christopher Waller added to the bond sell-off.

Yields on Treasury 3-year, 5-year, 7-year and 10-year notes all jumped at least 10 basis points after having fallen for most of the past 3 weeks. Tuesday’s move was exacerbated as US government debt played catch up to other financial markets after being shut on Monday for US Memorial Day. 

Sonal Desai, chief investment officer for fixed income at Franklin Templeton, wrote in a note: “We still need to acknowledge fully that inflation has become self-sustaining, and bringing it back under control will be harder and more painful than the central bank hopes. The Fed’s tightening cycle will be longer, and policy rates and bond yields will have to go higher than markets currently expect.”

Despite Tuesday’s sell-off, the US 10-year yield is still about 40 basis points below the high reached earlier this month, as investors began to see value once again in fixed-income assets. Investors are caught between elevated inflation and monetary policy tightening, which is aimed at slowing it, but is also increasingly seen as a threat to the economy.

Europe inflation

Bunds and other European bonds had dropped on Monday after German inflation accelerated to another all-time high, adding urgency to the European Central Bank’s exit from crisis-era stimulus. Inflation in Spain also unexpectedly quickened.

At the same time, Fed Governor Waller argued for more rate hikes until price pressures recede.

“I support tightening policy by another 50 basis points for several meetings,” he said in Frankfurt. “In particular, I am not taking 50 basis-point hikes off the table until I see inflation coming down closer to our 2 per cent target.”

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The slump in Treasuries also looks to be being driven by month-end portfolio rebalancing. JPMorgan Chase & Co estimates such flows may drive a 1 per cent to 3 per cent equity outperformance in the last week of May, as pension funds shift allocations to stocks from bonds.

Treasuries have returned 0.8 per cent in May, which would be the first monthly gain since November. The S&P 500 Index of US shares has risen 0.6 per cent.

Kit Juckes, a strategist at Société Générale in London, wrote in a client note that he is “not completely convinced” that Treasury 10-year yields have seen the cycle high: “Chances are that Treasuries will turn the screw at least one more time, probably this summer as rates rise by another 100 basis points.” BLOOMBERG