The sell-off of government bonds is deepening as the Fed opens the door to faster price increases

Fed Minutes Flag Probability of Earlier Rise, Balance Sheet Decline

The Treasury selloff that began the year developed after minutes from the Federal Reserve’s December meeting showed authorities considered raising interest costs before and quicker than recently anticipated. Yields on U.S. 10-year notes rose however much six premise points to 1.71%, the most elevated since April, while short-term trades markets began estimating in a 80% possibility of a 25 basis-point rate climb at the Fed’s March policy meeting. The jump was steepest for shorter maturities, with yields on two-year notes surging however much seven basis points to 0.83%, the most noteworthy since March 2020.

Federal Open Market Committee members also discussed starting to shrink the central bank’s swollen balance sheet soon after their first hike, the minutes showed. That would be a more aggressive approach than during the previous rate-hike cycle in the 2010s, when the Fed waited almost two years after liftoff to begin trimming the stockpile of assets built up as it injected cash into the economy.

The yield curve flattened, with the spread between five- and 30-year bonds shrinking four basis points to 67 basis points.

“These minutes are very hawkish, and it shows an FOMC that wants to lean against the market big time,” said George Goncalves, head of U.S. Macro strategy at MUFG. “The bond market still views policy tightening being primarily conducted through the front end,” which may mean that short-dated yields will lead the way higher until plans for shrinking the balance sheet come into focus, he said.

U.S. government bonds lost about 1% on Monday and Tuesday alone, adding to the 2.3% decline in 2021 that marked the worst year since 2013, according to data compiled by Bloomberg.

Wednesday’s loss exacerbated Treasuries’ poor start to the year, which has driven up 10-year yields by almost 20 basis points in just three days. The rout for global bonds extended in early Asian trading, with 10-year yields in Australia and New Zealand each rising by six basis points to reach levels last seen in November.

The already bearish mood was reinforced by the release of the minutes from the Fed’s December meeting, when it decided to conclude its monthly bond purchases by March, paving the way for raising its overnight benchmark rate. The minutes revealed that, on average, policy makers expect to raise rates three times this year.

The minutes also sharpened investors’ focus on the Fed’s balance-sheet decision as policy makers debated how the reduction of the central bank’s assets will intertwine with rates policy and how that may impact the shape of the curve. Fed Governor Christopher Waller said last month an early start to shrinking the balance sheet means “you don’t have to raise rates quite as much.”

The Fed’s balance sheet has doubled in size to more than $8 trillion since March 2020, when the central bank resumed buying Treasuries and mortgage-backed securities, first to stabilize the market and then to provide additional support to the economy as it held the policy rate at the zero bound. “It needs to be clear to watchers of the Fed that it’s a matter of when, not if, balance sheet reduction takes place,” Bob Miller, BlackRock Inc.’s head of Americas fundamental fixed income, wrote in a note after the minutes were released.

The reduction in the Fed’s asset doesn’t necessarily lead to a steepening yield curve, according to Ian Lyngen, head of U.S. rate strategy at BMO Capital Markets Corp. “QT is still T(tightening) — slowing upward pressure on inflation and creating a headwind to growth: both have historically been flatteners,” he wrote in a note to clients.

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