Treasuries rally as Fed chair signals continued monetary support

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US government debt rallied and the dollar weakened as the chair of the Federal Reserve pushed back against concerns about the inflation surge and reiterated the central bank’s commitment to maintaining its pandemic-era stimulus until there was more certainty around the strength of the economic recovery.

The yield on the 10-year US Treasury fell 0.05 percentage points to 1.37 per cent, while the ultra-long 30-year bond traded lower by roughly the same magnitude to hover below 1.2 per cent. The dollar index, which measures the greenback against a basket of trading partners’ currencies, fell 0.4 per cent.

Jay Powell gave his semi-annual monetary policy report to Congress on Wednesday after data showed US headline consumer prices rose 0.9 per cent between May and June, exceeding economists’ forecasts with the largest monthly gain since 2008. On a year-over-year basis, the consumer price index surged 5.4 per cent.

The Fed chair wavered little during his Congressional appearance from his longstanding view that the recent burst of inflationary pressures, which has been most pronounced in sectors associated with the reopening, will prove temporary.

While Powell did acknowledge that the pace of inflation has trounced initial expectations, he expressed confidence that price pressures would moderate over time as bottlenecks and other supply chain constraints ease.

Taken together with the shortfall of job gains and the need for further healing across the labour market, he affirmed the case for the Fed to keep policy accommodative for some time. The threshold for altering the central bank’s $120bn of monthly debt purchases was “a ways off”, he said.

Powell’s remarks come as a Bank of America survey published this week found that the share of investors who thought the economy would continue to improve dropped sharply from a peak of 91 per cent in March to 47 per cent this month.

Line chart of 10-year government yields (%) showing Treasuries rally as Powell signals continued monetary support

Mark Fielding, analyst at RBC Capital Markets, said “despite evident progress in terms of vaccinations and the expected reopening of global economies, markets have started to become more anxious that the expected growth rebounds might fade quicker than anticipated”.

“Bond yields have started to fall quite sharply again as a response,” added Fielding.

Wall Street stock markets hovered around highs as investors weighed up such concerns against expectations that second-quarter earnings would show the largest year-on-year increase since the financial crisis. The blue-chip S&P 500 was up about 0.3 per cent in afternoon trading in New York, while the tech-focused Nasdaq Composite was flat. The Europe-wide Stoxx 600 benchmark closed down 0.1 per cent, remaining near its record hit this week.

“We are likely seeing peak growth, peak inflation, and peak stimulus in many countries right now,” said Mark McCormick, global head of currency strategy at TD Securities. “Markets are slowly absorbing this turning point, but with Delta [coronavirus] cases rising quickly, the outlook remains highly uncertain.”

Elsewhere, UK assets were jolted by data showing the country’s rate of inflation was running ahead of the Bank of England’s target, piling pressure on the central bank to reduce its own debt purchases.

UK consumer prices rose 2.5 per cent in the 12 months to June, data on Wednesday showed. Sterling gained 0.4 per cent against the dollar to $1.388 and the blue-chip FTSE 100 dropped 0.5 per cent.

Derivative markets linked to the path of BoE rates on Wednesday priced in an increase in UK interest rates to 0.25 per cent by November 2022. Before the inflation data, such an increase was expected by May 2023.

BoE policymakers “will undoubtedly still insist price pressures will be shortlived”, said John Wraith, head of UK rates strategy at UBS. “But the higher the rate goes in the interim, both absolutely and relative to their own forecast, the more that conviction will be undermined.”

Brent crude, the global oil benchmark, dropped 2.3 per cent to $74.69 a barrel following news that the UAE and Saudi Arabia were close to an output deal that would raise production among Opec+ members.

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