US Treasuries stable after Fed minutes undercut inflation warnings

US Treasuries regained a little lost ground on Thursday after the latest Federal Reserve minutes indicated that most officials thought the bigger threat to the economy came from subdued inflation, rather than the faster price rises feared by bond investors.

Government debt has sold off in recent weeks after US president Joe Biden’s proposed $1.9tn fiscal stimulus stoked fears of consumer prices rising rapidly. Inflation makes bonds less attractive by eroding the value of their interest payments.

Minutes of the Fed’s January meeting, published on Wednesday, showed most of its policymakers believed the continued weakness of the coronavirus-scarred economy meant inflation risks were “weighted to the downside”. They added that the pandemic “continued to pose considerable risks to the economic outlook”.

The yield on the benchmark 10-year Treasury dropped 0.01 percentage points to 1.29 per cent on Thursday, as the price of the debt rose. The yield had reached 1.33 per cent earlier in the week — its highest in a year — after rising inflation expectations encouraged selling.

The central bank has held yields lower since March last year, when it launched a massive bond-buying programme, accompanied by interest rate cuts, sending benchmark yields below 0.5 per cent.

Those record low yields have supported a blistering rally in stock markets. A rising risk-free rate now reduces the present value of companies’ future cash flows, sapping stock valuations. Analysts are looking for the tipping point where the Treasuries sell-off can seriously trouble stock prices.

“The run-up in Treasury yields is now a headwind for stock markets,” said Sophie Chardon, cross-asset strategist at Swiss bank Lombard Odier. “You can see it is already dampening momentum.

“You now cannot expect [company] valuations to go higher because of the mechanics of the market,” she added. “You need earnings growth and you need to be much more selective about what you invest in instead of being bullish towards equities overall.”

In stock markets on Thursday, Europe’s regional Stoxx 600 slid 0.4 per cent and the UK’s FTSE 100 fell 0.7 per cent. Futures markets signalled Wall Street’s S&P 500 would lose 0.5 per cent in opening trades.

Companies whose prospects were pinned to improving economic growth outperformed, however, with shares in basic materials businesses leading the Europe-wide and the London indices.

Shares in such businesses, along with banks, were the least threatened by a run-up in bond yields and inflation, said Dan Ison, senior portfolio manager at Columbia Threadneedle.

“Ultimately, what rising bond yields tell us is that economic growth rates are going to be a lot higher,” Ison said. “Financials, materials, chemicals and construction businesses will be strong beneficiaries of improved economic growth.”

Oil prices, which have been boosted by prospects of coronavirus lockdowns ending, continued their ascent. Brent crude, the international benchmark, topped $65 a barrel in early trading, reaching its highest level since the beginning of 2020. It recently traded up 0.4 per cent for the day at $64.58.