The US yield curve steepened sharply on Thursday following the Federal Reserve’s announcement that it would allow inflation to run above its longstanding target in order to make up for periods of undershooting.
The difference between five-year and 30-year Treasury yields widened to the largest gap in three months — 119 basis points — thanks to a sizeable sell-off in longer-dated Treasuries.
The yield on 30-year Treasuries, which rises as prices fall, surged over 0.08 percentage points at one point to 1.5 per cent, the highest level since June. The yield on the benchmark 10-year note rose 0.05 percentage points to 0.52 per cent, while five-year Treasury yields climbed by a smaller magnitude of 0.03 percentage points to hover around 0.3 per cent.
Investors attributed the back-up in longer-dated Treasury yields to the possibility of higher inflation, which erodes the real return that bondholders earn on their fixed interest payments for government debt.
In order to achieve higher inflation than it has managed in recent years, the Fed is likely to hold short-term rates very low for a long time. Two-year Treasuries barely budged, their yield steady at 0.15 per cent.
According to plans laid out by the Fed at its virtual monetary policy symposium, the central bank will now adopt an average inflation target, in which it will sometimes allow for inflation to run above the 2 per cent target that has grounded its policy approach for decades.
Michael de Pass, global head of US Treasury trading at Citadel Securities, said that long-term Treasury yields had previously signalled that achieving the 2 per cent target was unlikely. At the start of the month, the 30-year Treasury note was trading at a yield of 1.20 per cent, he said.
“Given the recent back-up in yields, some of that pessimism has subsided,” Mr de Pass said.
“Be careful what you wish for,” said David Kelly, chief global market strategist of JPMorgan Asset Management. “There is a risk that overall inflation will overshoot [the central bank’s] target and they won’t have the political will to pull in the reins before it becomes a problem.”
That risk suggested the yield curve should steepen further from here as longer-dated Treasuries fall out of favour at a faster pace than their short-term counterparts, Mr Kelly said.
The glut of longer-dated Treasury supply hitting the market was likely to pile additional pressure on prices and keep yields higher, analysts said. The US government is funding record-setting relief packages designed to pump money into the coronavirus-hit economy.
While auctions this week for two-, five- and seven-year debt were met with strong demand, the Treasury department has recently struggled to offload large blocks of 20- and 30-year bonds.
According to strategists at TD Securities, the steepening of the yield curve also reflected disappointment among investors about the lack of detail from Mr Powell about the Fed’s bond-buying programme.
The central bank has committed to buying Treasuries of all maturities at a pace of $80bn per month but some investors had been calling for the Fed to purchase relatively more long-term debt, to reflect the increased supply and hold down their yields.