Shorter-dated US government bonds dropped in price on Monday in the latest sign of how investors are expecting the Federal Reserve to aggressively tighten monetary policy in an attempt to rein in inflation.

The yield on the two-year Treasury note, which moves inversely to its price, rose 0.09 percentage points in European morning trading to 2.39 per cent, leaving it up more than 1.6 percentage points since the end of last year.

Short-term bonds have sold off more vigorously this year than ones at the longer end of the spectrum as expectations for a series of Fed rate rises in the coming months weigh on the longer-term economic growth forecast.

“The market is pricing a significant overshoot in inflation and central banks being forced to react strongly, triggering an economic slowdown,” said Luca Paolini, chief strategist at Pictet Asset Management.

In a sign of those concerns, the five-year Treasury yield on Monday rose above the 30-year yield for the first time since 2006. A so-called yield-curve inversion of this nature reflects concerns that the Fed’s attempt to battle inflation could over time depress growth or even cause a recession.

Line chart of difference between 30- and 5-year Treasury yields (percentage points) showing the US yield curve is flashing a warning sign

Consumer price inflation in the US hit a 40-year high of 7.9 per cent in February, with analysts expecting the surge to continue as price disruptions caused by industries reopening from coronavirus lockdowns are exacerbated by the Ukraine war causing soaring commodity costs.

“Geopolitical uncertainty has caused energy prices to surge, has put pressure on other raw materials and has caused further disruptions to supply chains,” said Sonal Desai, fixed income chief investment officer at Franklin Templeton.

“To bring inflation under control, in my view, the Fed will need to implement a much more aggressive policy tightening than it currently envisions.”

Citigroup analysts said last week the US central bank was likely to raise borrowing costs by half a percentage point at every one of its monetary policy meetings from May to September. Goldman Sachs analysts said on Friday that they now expected the 10-year Treasury yield, which stood at just over 2.5 per cent on Monday, to hit 2.7 per cent by the end of 2022.

Ructions in the US Treasury market also spread to eurozone bonds. Germany’s five-year bond yield rose as much as 0.1 percentage points to 0.429 per cent, the highest level since 2014.

Europe’s Stoxx 600 share index rose 0.7 per cent as investors cautiously welcomed a declaration by Ukrainian president Volodymyr Zelensky that the nation would declare neutrality and abandon its plan to join Nato if Russia withdrew its troops. An index of European bank stocks rose 2.4 per cent.

The price of Brent crude oil fell 3.3 per cent to $116.92 a barrel, still about a fifth above its closing level of February 23, on the eve of Russia’s invasion.

Futures markets implied Wall Street’s S&P 500 share index would slip 0.3 per cent in early New York dealings. Asian stock markets were mixed, with Japan’s Nikkei 225 closing 0.7 per cent lower and Hong Kong’s Hang Seng adding 1.3 per cent.

The dollar rose 1.5 per cent against the Japanese yen, with one unit of the US currency now buying ¥123.4, its highest level since 2015 as traders bet on the Bank of Japan maintaining loose monetary policy while the Fed raises interest rates.



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