Yields on U.S. government debt slipped on Wednesday as investors digested the first of two days of congressional testimony from Federal Reserve Chairman Jerome Powell, who reiterated the view that the recent strength in inflation is due to temporary supply issues as the economy recovers from the pandemic.
Investors also digested a reading of the June producer-price index, which jumped to the highest annual level since the index was overhauled in 2010, and likely one of the highest readings since the early 1980s.
How Treasurys are performing
- The 10-year Treasury note TMUBMUSD10Y,
1.325% yield slipped compared with 1.415% at 3 p.m. Eastern Time on Tuesday. - The 30-year Treasury bond TMUBMUSD30Y,
1.943% fell from 2.037% a day ago. - The 2-year Treasury note TMUBMUSD02Y,
0.229% also eased from with 0.255% on Tuesday.
Fixed-income drivers
Data on Tuesday showed U.S. consumer price inflation rising further, putting Powell’s testimony over the next two days in greater focus.
However, the Fed chairman, in prepared remarks, said that the sharp rise in inflation seen so far this year will ultimately dwindle away. He also took a litany of questions of lawmakers’ questions on the topic, and played down any direct link between the Fed’s purchases of mortgage bonds and a spike in home prices.
Powell’s comments came as a reading of the producer price index on Wednesday jumped 1% last month, far exceeding estimates by economists polled by The Wall Street Journal who had forecast a 0.6% increase.
The pace of wholesale inflation over the past 12 months rose to 7.3% from 6.6% in May. That is the highest level since the index was overhauled in 2010, and likely one of the highest readings since the early 1980s.
The Fed has insisted for months that price rises caused by widespread shortages will eventually ease once the U.S. and global economies return to normal after the pandemic. Powell, in his testimony in front of the House Financial Services Committee, said “very high” recent inflation readings appear to be coming from goods and services directly tied to the reopening of the U.S. economy.
However, the chairman said that “we are monitoring the situation very carefully” and the Fed remains committed to price stability. If policymakers see inflation remaining high for a period of time and beginning to uproot expectations, “we would absolutely change our policy as appropriate,” he said.
The Fed is holding its policy interest rates in a range between 0% and 0.25% and buying $120 billion of Treasurys and mortgage-backed bonds each month to keep interest rates low.
Powell’s remarks suggest that the central bank is in no rush to remove monetary accommodation, but he noted that discussions among Fed members are under way. Meanwhile, the Fed’s Beige Book report released Wednesday found that a “robust” U.S. economy is strengthening, but also grappling with big shortages and higher inflation.
Minutes of the Fed’s June meeting show that officials had a lengthy discussion about when to slow down, or taper, the asset purchases. That is the likely first step in backing away from its easy money policy stance and investors will be looking for Powell to provide any clues on those plans.
On Tuesday, Federal Reserve Bank of San Francisco President Mary Daly told CNBC that a tapering of bond purchases could begin late this year or early next, and that she’s convinced the recent spate of inflation will prove to be short-lived.
Fixed-income investors on Wednesday are also keeping an eye on a Senate Democrat budget agreement, which envisions spending $3.5 trillion over the coming decade, paving the way for their drive to pour federal resources into climate change, healthcare, and family-service programs sought by President Joe Biden.
What strategists, traders, and others say
“We read Fed Chair Powell’s prepared remarks for congressional testimony today as leaning against the possibility of an earlier tapering decision in September,” said Krishna Guha of Evercore ISI.
Still, “we do not see him as abandoning this hawkish option,’” Guha wrote in a note to clients.
Robert Ostrowski, chief investment officer of global fixed income at Federated Hermes, says that the firm’s analysts aren’t hearing much evidence of a shift in inflation psychology, even if they have noticed shifts in actual cost inflation.
“We’ve already reached peak/transitory inflation and the hullaballoo over rising prices is overdone,” Ostrowski wrote in an emailed note. Like many, “our fixed-income team is scratching its collective head over the behavior of long yields” — which doesn’t fit with “an economy growing at its fastest pace in 40 years, core inflation that’s rising the most in a decade, and a fiscal backdrop that’s racking up record trillion-dollar-plus deficits,” Ostrowski said.
In the firm’s model portfolios, “we are maintaining duration well short of benchmark and positioning for a steepening yield curve, albeit at a more moderate pace than where we stood in the second quarter.”
