An avalanche of hot inflation data over the past month has lifted US borrowing costs to the highest point in a decade and a half, intensifying debate over how much further interest rates must rise to rein in soaring consumer prices.
The yield on the two-year Treasury note hit 4.94 per cent on Thursday, a level last reached in 2007 before the global financial crisis. Yields on 10-year and 30-year Treasuries this week broke through 4 per cent for the first time since November.
The moves follow weeks of unrelenting data showing inflation in the US running hotter than economists had expected, putting pressure on the Federal Reserve to redouble efforts to tamp down growth by raising interest rates.
“I don’t recall this dramatic of a reassessment of economic conditions in such a short time period, with the exception of major shocks like Covid-19 and the collapse of Lehman Brothers,” said Rick Rieder, global chief investment officer for fixed income at BlackRock, the asset manager.
He added: “I would never have thought you would have seen this kind of re-acceleration in inflation.”
The latest in the string of hot inflation data was a report released on Thursday that showed unit labour costs — the average cost of labour per unit of output — rose 3.2 per cent on an annualised basis in the last quarter, revised up from a previous estimate of 1.1 per cent.
Last week came an acceleration in the Fed’s preferred gauge of inflation, the personal consumption expenditures price index, to 0.6 per cent month on month in January from 0.2 per cent in December. Early in February, the US reported that consumer price index in January had cooled less than economists had forecast.
The initial trigger for the bond sell-off was a US jobs report on February 3 that said more than half a million workers had been hired in January, nearly three times what economists had expected. Taken together, the economic data has dashed hopes the Fed will soon be able to pause interest rate increases.
The outlook for borrowing costs will be in focus next week as Fed chair Jay Powell testifies in front of Congress just days before the next jobs report, in which the US is expected to report that 215,000 people were hired in February.
On Thursday, Fed governor Christopher Waller said that if inflation and jobs data cool off, he would endorse a peak in interest rates between 5.1-5.4 per cent, up from current levels of 4.5-4.75 per cent. But if the data continues to come in too hot, “the policy target range will have to be raised this year even more”, he said.
Futures markets show investors are now betting that the Fed’s critical policy rate will peak at 5.45 per cent in September before dipping slightly to 5.33 per cent at the end of the year, higher than the Fed’s last forecast of 5.1 per cent, issued in December. At the start of February markets had been pricing in a peak in rates in the second quarter just below 5 per cent, with two interest rate cuts by the end of 2023.
“Markets have caught up with the data and the Fed. That is evident in the move in Treasuries,” said Adam Abbas, co-head of fixed income at Harris Associates.
Adding to evidence of resilient US economy was data Thursday showing a drop in new unemployment claims in the week that ended on February 24. Weekly initial claims figures have been less than 200,000 since early January after spending much of last year above that level. Stronger jobs data suggests upward pressure on wages, one big driver of inflation.
“The market had gotten way ahead of itself with the ‘inflation is dead’ narrative,” said Matt Raskin, head of US rates research at Deutsche Bank.
The Fed next meets on March 21-22. Economists expect the central bank to lift its policy rate by another 0.25 percentage points, matching the increase announced at its meeting last month. The rate of increase is less than the half-point and 0.75-point rises the Fed executed several times last year.
“The Fed has a problem because they have already moved down to 0.25 percentage points. The status quo does not work for the US central bank right now,” said Ajay Rajadhyaksha, global chair of research at Barclays.